High-Yield Income And Balance Growth Continues: Q1 2017 (BDC, mREIT) Update

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Includes: AGNC, AI, BDCL, BXMT, HTGC, NRZ, TCRD
by: High Yield Investor

Summary

I just achieved my long standing benchmark; dividend income 75% of my current gross employment earnings.

The first quarter of 2017 price alpha continues where 2016 left off.

Portfolio yield is 9.8% and with price appreciation the yield is declining.

Introduction…

Over the years it has been challenging to make sense of a dynamic market related to high yield investments. For the record my term "High Yield" refers to yields greater than 7% and typically in the 10% range. My only aspiration is to increase yearly income "Cash-Flow" year after year while withdrawing a percentage of dividends to pay expenses. This withdraw method prevents the selling of stock to pay expenses.

Keeping goals simple makes them achievable.

In my previous article I outlined a case study of what to expect when exclusively investing in BDCs (Business Development Companies) and mREITs (mortgage Real Estate Investment Trust) during a Bull And Bear Market. It was my plan from the beginning to build a portfolio that will generate income in both market cycles.

The first quarter 2017 results continue to build on the price gains of last year. The fear of the FED one quarter point increase on March 15th having a negative reaction to my high yield investments did not materialize, but instead the opposite occurred. With last year's cash dividends I've been taking advantage of dips in the market to increase my total dividend income. I would prefer lower entry prices, but since this is my transition year I wanted my portfolio to produce as much income as possible.

Background…

I've been planning my escape over the past few years and the time has come to move from the dependency of others to self-reliance. It's hard to believe only a few short years ago I had no idea how to replace my paycheck. The choice was to continue working until I did a face plant at my desk or to be creative with the limited funds I had available. It's been a learning process and I have selected stocks for the sole purpose of creating income.

I can now say I have achieved my original goal of generating enough dividend income to replace 75% of my current gross employment earnings. From the beginning I put in place a system to achieve my intent to generate passive income during a bull or bear market. It was designed on a portfolio yield of 10% and continues to this day. This design comes with a great deal of risk and may not be applicable to most investors.

Investing Philosophy…

I'm sure investors don't know what to think of my high yield investment method in trying to achieve a 10% yield with only two asset classes. It is based on the concept that BDCs outperform when the markets are flat to up and agency mREITs outperform when markets are flat to down while collecting yields above 8%.

From the start I established my method to always be in the accumulation phase. This one requirement directed my design to concentrate on investments that generated more dividends than needed in retirement. This concept places the emphasis on income generation and not price appreciation. Stocks will not be sold to generate income, but surplus dividends will be reinvested to grow the income stream.

As a long term income investor I believe price is an illusion of deceit that preys on investor's misguided emotional response that damages their long term objectives. Price appreciation as the only goal placed on us by financial institutions and the media try to portray their false narrative as truth. This ill-advised notion trips up investors in achieving their long term objective. Income "Cash-Flow" derived from financial assets provides an alternative to human capital replacement.

It is a losing proposition to count on price as the corner stone of any income method. Price is shaped by market perception that can change on a dime. This is one of the reasons I separate capital gain from income cash flow in my analysis. They are two separate variables, one imaginary and the other tangible as passive income hitting my account.

What does this mean for price? I use price to acquire more income producing shares at lower cost. With this in mind I have eliminated the false emotional response to a price decline as something to be feared. Instead it is a time to rejoice and brush off the cobwebs from my piles of lazy unproductive dividend cash and put them back to work.

2017 first quarter results…

Last year my Q1 2016 results listed an interesting chart "The Wild and Crazy Market" with price action that included the February and March rapid price decline, The Road Less Traveled Accelerates Income Cash Flow. The article elaborated on my concepts that still hold true. Needless to say I depleted my dividend idle cash by purchasing more income producing shares. I bring this up because I have just created a simple Chart 1 that represents both my BDCs and mREITs in relationship to the SP500 and the yield spread between the 30 year and 10 year Treasury interest rates. Since both asset classes are rate sensitive, I wanted to know how they react to the FED rate increases and the Treasury changes perceived by investors. This historical chart can give me an edge in the accumulation of more income producing shares when my stocks decline.

The Upward Complacent Market, Chart 1:

This chart is created using a fixed share quantity at the beginning of the year to evaluate only price gains without dividend reinvestment. Year to date the SP500 is sitting at a 5.8% gain, the BDC component of my portfolio is at 6.3% gain and the mREITs at 5.5%. They have diverged at times, but are now in sync at the end of the first quarter.

I included the SP500 as a reference point that is more aligned with business development companies then the mREITs. The red line contains 21 individual BDC stocks and the green line contains 19 individual mREIT stocks in my portfolio. The inverse correlation of the mREITs to BDCs is not apparent since they both have taken off since February 2016. I would expect the inverse relationship to take place once the 10 year rates normalize in the 3 to 3.5% range and we enter into a recession. Until then both assets have been beaten down so much in 2013 and 2014 they still have a way to go for price to normalize along with Treasury rates.

Looking at Chart 1, both BDC and mREIT investors perceived fear the day before the FED increased rates by 0.25% based on a false tighten-stance narrative. The FED increased rates March 15th, but reported a more dovish-stance and both asset classes moved up. We all knew the FED was going to bump the rates one quarter point, but investors did not know if the FED would become more aggressive or take a measured approach to increasing rates.

So there you have it; the FED is becoming dovish and investors sold the perception and locked in losses and the very next day went on a buying spree. Sell low and buy high is alive and well and some investors will take advantage. This happens all the time and needless to say I was a buyer when investors became sellers. Just look at the recovery in price. Once again I'm in a waiting mode ready with my list of stocks to purchase the next time fear grips the market.

Actual Income Change From 2016, Chart 2:

This is my typical progress chart. The portfolio balance includes new purchases made during the first quarter plus price gains. The dividends are accumulated each month and compared to last year dividends. The dividend percent change shows the increasing "Cash-Flow" growth rate on a monthly basis.

The solid red line is the portfolio balance growth since December 30th of last year. This includes both capital gains plus reinvestment of dividends. I intend to put all dividends back to work before I retire in a few months.

The green bar is the actual dividend cash hitting my account each month as the percentage change from last year. Investments made during 2016 are starting to pay-off as increased dividends this year. The investments I just made in the first quarter of 2017 will start to show up later this year.

Market Value and Income, Chart 3:

This chart demonstrates the power of high yield investing and the accumulation of dividends to paper gains at a given point in time. This is why I separate both variables since price is imaginary unless sold and converted into cash, and dividends already in cash hitting my account. This visual reality of my current portfolio demonstrates a number of aspects.

  1. The YOC (Yield On Cost); depends on the timing of my purchase. Lately the market value of all my investments have increased in value making each purchase more expensive.
  2. The YAM (Yield At Market); is the current yield of my portfolio based on market value. Price has increased on most of my stocks lowering this yield.
  3. The MktVal (Market Value); I call this imaginary price, because it is dynamic in nature that changes by the minute. It is just a representation of market perception by all investors and is not realized until an investment is sold.
  4. The TotRet (Total Return); is the combination of the current market value plus all the dividends collected for each stocks.

I wanted to show this chart again with all my current investments that highlight the buy-hold-reinvest approach when using high yield as your income vehicle. The cool thing about high yield is the fact I only started back in the 2013 to 2014 time frame. This was not the best time to invest since most investments were priced very high.

Since then some of my purchases have continued to decline creating the first impression of a losing position. When I add the dividends collected over time to each investment it is plain to see the incredible reality of a high yield investor. My investment method does not look at total return, but income growth only. As I said before if you focus on income growth the portfolio will take care of itself. This chart proves this theory.

I do not drip the dividends back into the same stocks that make the distribution, but let them accumulate as cash. This allows two items of my investment method to be accomplished. The first is to be deterministic in my purchase timing and the second is adding shares to stocks that need their income allocation increased.

  1. As indicated in the chart the blue bars for the BDCs on the left side of the chart ETRACS 2X LEV LNG WF ETN (NYSEARCA:BDCL) to HERCULES TECHNOLOGY (NASDAQ:HTGC) show market value gains are higher than the mREITs on the right side of the chart ARLINGTON ASSET (NYSE:AI) to NEW RESIDENTIAL INVT CORP (NYSE:NRZ). For each stock the blue bars indicate the gain/loss if sold at market, but the green bars indicate the total return of the stock.
  2. The left most stock BDCL if sold today would lock-in a loss of 22%, but the total return would be almost 12%. For AGNC INVESTMENT CORP (NASDAQ:AGNC) the market loss would be over 24%, but because I have collected the dividends for many years the total return for this stock is 28%.
  3. Look at THL CREDIT INC (NASDAQ:TCRD) a market loss of 1% with a total gain of over 52%; the longer a high yield stock is held the sooner the initial investment will be realized. Then there is HTGC with a paper gain of 29% and a total return of almost 57%, and NEW RESIDENTIAL INVT CORP with a paper gain of almost 46% and with the dividends a total return of almost 54%. I purchased NRZ just last year and want to thank The Fortune Teller for bringing this bad boy to my attention.
  4. And to be fair Brad Thomas brought this high yield stock to my attention, BLACKSTONE MORTGAGE (NYSE:BXMT) having a paper gain of 16% and a total return of 28%. To me this was a chasing yield moment for Brad, but in the commercial high yield area.

I wanted to show this chart because most investors just look at price as the main focus for success of an investment, but I want to emphasize the importance of dividends for an income investor. This makes all the difference in achieving their mental perspective if they can visualize the effects high yield has on their total portfolio.

Conclusion

The year 2017 has continued where 2016 left off. Since February 2016 the BDCs and mREITs continue to climb in price. I know there is a lot of uncertainty in the markets and pundits continue their rhetoric to expect a decline any day now, but I can't see a recession anytime soon. If we do experience a pullback it will be a correction only and a good time to add positions. The catalyst for a recession does not appear to be here yet, but will get closer if market price accelerates at a parabolic rate meaning everyone wants to jump in and not miss the gains. At that point it will be too late and the experienced investors will start moving out until no buyers are left.

As for my retirement I have achieved my long standing goal of reaching my 75% paycheck replacement goal. I only plan using about 60% of the dividend income for reinvestment and grow the "Cash-Flow". The surplus reinvestment cash will be three times my 10% 401k employment contributions I've been making over the past few decades. What this means is my 50/50 portfolio will grow three times faster when I finally quit work.

As a final note, high yield investments are not the big scary monster hiding under the bed ready to destroy an investor's portfolio. I have built an extreme turbo charged portfolio so unique most investors would not take a chance putting their entire retirement future at risk. The way I see risk is only on the income side just like my working career. If you understand price as only the means to an end to increase income the mental distress can be reversed.

Investment Disclaimer

Please note the stocks included in the 50/50 portfolio are not recommendations. They were personally selected by the author and contain a great deal of investment risk. The stocks in the portfolio are Business Development Companies [BDCs] and mortgage Real Estate Investment Trusts [mREITs]. Both investment vehicles are Regulated Investment Companies [RICs] and are required to distribute at least 90 percent of taxable income as dividends to investors.

This is a live active IRA portfolio that I believe will withstand the markets' bull and bear movements based on my own research. The progress will be updated and tracked for feasibility of this investment method over the years. The article titled 50/50 Portfolio (BDCs And mREITs) Baseline 2014 details how the portfolio was constructed. It must be noted that investment selections are dynamic and based on management's ability to navigate economic conditions.

In a most recent article dated February 2017, I outlined a case study of what to expect when exclusively investing in BDCs (Business Development Companies) and mREITs (mortgage Real Estate Investment Trust) during a Bull And Bear Market.

Disclosure: I am/we are long ALL STOCKS IN THIS ARTICLE.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.