Happy New Year everyone. Our "Income Factory" continued to churn out the cash as it has all year, finishing up with a total cash income stream for 2017 of 11.8%, just about what we projected in our third quarter report, at which point we had collected 9% for the first nine months and were sporting a 20% total return.
As we have written previously, our goal is to maximize the income stream and not pay so much attention to how the market values the "factory" that produces that stream. In fact, as we have demonstrated mathematically on several occasions (including the one just cited), from a long-term income growth perspective, we actually do better and grow our income stream faster if the market is flat or down, rather than rising, since (1) the key to long-term income growth is re-investment and compounding, and (2) you do that faster when you can re-invest and compound at flat or lower prices (and correspondingly higher yields) rather than at rising prices.
But we're also human, and seeing the market pat us on the back and agree with our investment choices once in a while is good for the soul and makes you feel less like you're out there by yourself swimming upstream.
So it's been a good year from both the perspective of seeing the income factory grow, and being patted on the back as well.
Our portfolio consists of funds (mostly closed end funds) that are selected primarily to generate steady income in the high single-digit range or above (i.e. 9-10% and up). In other words, I want to earn an "equity return" even though the funds may hold a variety of equity investments, debt instruments or special purpose vehicles.
The idea is that if you can earn cash income of 9-10% and re-invest and compound it, under the "rule of 72," you will double your money every 7 or 8 years, which provides all the growth anyone needs to steadily build for retirement (or any other purpose that requires a future income), whether the investor is 25 years old or 65.
I use closed end funds for several reasons:
- To avoid the "run on the bank" risk of open-end mutual funds with redemption features that can force fund managers to sell solid long-term assets at the worst times because of market panic or insecurity.
- The ability to get modest leverage at cheap institutional interest rates.
- And to ensure diversification; many of the high yield assets I like would be far more risky to buy as individual securities, but in diversified pools. the risk becomes capable of being modeled, predicted and managed.
Here is a current breakdown of the portfolio by category:
Most asset classes are the "usual suspects" you might expect in a high yielding income-oriented portfolio:
- "High Yield" debt and the CLO funds share the leadership position at 17% each. Major additions or increases were: Pimco High Income Fund (PHK), whose stellar record and attractive distribution (almost 13%) made me overcome my normal aversion to paying a premium (which in this case, at 10%, was way below - less than half - its average level recently); Brookfield Real Assets Fund (RA) which I continue to like (10.2% yield, -7% discount); and Barings Global Short Duration HY Fund (BGH) which has become my "short duration" high yield fund of choice (9.2% yield, -7.49% discount) replacing Franklin Limited Duration Fund (FTF). (FTF has a higher yield and a good record, as does BGH, but BGH's distribution looked a little more secure; plus I have always really liked its management company, part of the Mass Mutual group. Anyone still holding FTF, don't panic; I have no reason to think it is not also a good hold although it has a larger negative UNII than BGH.)
- I also sold down a bit of my MFS Intermediate High Income (CIF), which yields a nice 9% but moved into premium territory (6%). I love this fund and am proud to have "discovered" it a couple years ago when it sold at nice discounts. Nobody will go wrong continuing to hold it for the long term, although it may drop back to a discount at some point. Other alternatives include those I mentioned, plus NexPoint Credit Strategy (NHF), to which I added slightly and which yields 9.5% at a -4% discount
- My CLO funds - Eagle Point Credit (ECC) and Oxford Lane Capital (OXLC) - continue to pump out solid cash flow and distributions although the cash flow coverage, while adequate, seems a bit thinner than it was in the past, probably due to compressed spreads in the senior corporate loan market (which is offset to some extent by improvements - i.e. decreases - in funding costs for the CLOs' own liabilities.) These funds hold equity in CLOs (collateralized loan obligations), that themselves are leveraged, securitized portfolios of senior floating rate corporate loans. That makes CLOs somewhat like "virtual" commercial banks. Because of CLOs' securitization structures, funds that buy them will always have more complex moving parts and be somewhat more opaque and volatile than typical closed end funds, regardless of how much their managements try to explain them and various Seeking Alpha authors try to unravel them. (As I tried to explain recently.) Personally, I believe I own a little too much of them for a prudent portfolio, but because (1) I know a bit about CLOs from my previous life (just enough to be dangerous), (2) believe in the structure and the economics behind it, (3) feel comfortable with the management of ECC and OXLC, and (4) love the high yields, I have been slow to reduce my exposure (although note it has come down slightly from last quarter; from about 19% to 17%.) Ideally I should probably limit it to 15%, and I would not advocate any readers going even that high unless you really believe you understand the asset class and its various idiosyncrasies. CLOs, by the way, should do well in an improving economy where interest rates are rising, since credit default rates should stay low as the economy grows and the floating rate loans will increase their coupons as interest rates rise.
- One high yield bond fund I sold down but plan to repurchase is Aberdeen Income Credit Strategies Fund (ACP), formerly known as Avenue Income Credit. A few months ago, the fund changed its name and also its advisor, becoming a part of the Aberdeen Asset Management Group, one of the UK and Europe's largest investment firms. I had a good experience with ACP, which pays a distribution of 10.2% and sells at a -6% discount, but its online presence and CEFConnect link fell a little behind the reality of the management switch in recent months, so the story (which I think is a positive one, Aberdeen being a highly respected outfit) got a bit blurred for me and I chose to sell down my position and move into other funds that I understood better. I am looking forward to Aberdeen getting more up to date information out on the fund in the near future, and expect to be increasing my holdings up to previous levels over time.
- The MLP sector has been an adventure. I got into this mostly last summer because I thought it was an essential industry that would eventually bounce back and seemed to be paying great distributions in the meantime. I felt a bit exposed when much of it dropped further through the autumn, but fortunately many of my "losers" in terms of paper losses a quarter ago, have largely turned the corner since then. EFTIS InfraCap MLP ETF (AMZA) is now still slightly underwater for me but pumping out its dividend at about 24% a year. My other MLP investments, Duff & Phelps Select Energy MLP (DSE), distributing 15%, Fiduciary/Claymore MLP (FMO) at 13% and ClearBridge Energy MLP Opportunity (EMO), paying 10.8%, are all back above my purchase price and possibly going higher, so that seems - in retrospect - to have been a good decision (although I hasten to remind myself that, in theory, I don't really care about the market gains; on the other hand, since I'm not looking to increase my exposure to MLPs right now, the increase in price doesn't hurt me, since I'm not reinvesting and compounding distributions into these funds.)
- My various "Equity" fund categories, if I added them together, would be the biggest sector, but I have differentiated between the "equity option" funds that hedge themselves as a matter of policy, stating that they deliberately trade away the potential upside in order to ensure a steadier albeit lower return, from those that seem to be clearly income oriented, in some cases even being "balanced" funds with equity blended with bonds or convertibles.
- My Equity Option funds: Voya Global Equity (IGD), Eaton Vance Tax-Managed Global Dividend (EXG), Eaton Vance Risk-Managed Diversified Equity (ETJ), and Guggenheim Enhanced Equity Income (GPM) have all been very successful investments, paying distributions in the mid 9% range for the first three, and 10.8% for GPM, while all rising in market value as well. I like the concept of trading away some of the market gain to get steadier income. In a recent article I had a commenter take me to task for calling these "income factory" type funds because he/she said they had similar "beta" to ordinary stock funds because I got all my total return (excluding the cash dividends) from them last year from the stock appreciation and not from the option income. I think the reader missed the point. In a year when the stocks are rising, funds like these don't expect to make money from the hedges they put in place betting that their stock holdings will go down. They will make their money on the appreciation. It is in the years when their holdings are NOT appreciating that the bets they make that they will drop will pay off, providing some income from the hedge to offset the market appreciation that isn't there (or the market depreciation that is there.) Even though I don't personally invest directly in options and hedges, this seems pretty straight-forward to me. It also seems like a logical way to turn more naturally volatile equity investments into lower risk/reward profile, steadier income-like investments. And thus, logical candidates for an "income factory" approach.
- What I call my "Equity/Income" funds are a little different in that they don't rely on options per se to convert themselves into more of a fixed income vehicle, but do a variety of other things: (1) like invest primarily in high yielding utilities, energy and infrastructure companies (Miller Howard High Income - HIE); or (2) invest in a blend of equities and convertibles (Calamos Global Dynamic Income - CHW - a superstar fund yielding 9.25% and now selling at par that I took substantial profits in and rotated into other funds at greater yields and/or discounts) or (3) a blend of utilities and infrastructure stocks plus bonds and asset-backs, like Virtus Total Return (NYSE:ZF), yielding 11.2% and a discount of -4.4%.
- Finally I also added a starter position in the more straight-forward but high-yielding Gabelli Equity Trust (NYSE:GAB), which has a great record and seemed to be at a historically attractive entry point a few months back (10.34% yield and a discount of -4.3%). Thanks to LeftBanker's article for bringing this opportunity to my attention.
- My High Yield/Convertibles sector has been a superstar category, paying a solid 9 to 11% return and racking up substantial capital gains. Unfortunately four of the five funds - Allianz Convertible & Income (NCV), Allianz Convertible & Income II (NCZ), Calamos Convertible & High Income (CHY) and Calamos Convertible Opportunity & Income (CHI), while yielding 11% (the first two) and 10% (the next two) are all selling at slight premiums now. Allianz Diversified Income & Convertible Fund sells at a discount (-4%) and yields a still attractive 9.2%.
- I continue to like the business development company ("BDC") sector, especially if the economy continues to improve and interest rates rise (eventually; probably not too fast too soon; see below), since the small and middle market businesses BDCs lend to should do well in such an environment, and the loans BDCs make are mostly floating rate. I also like diversification and professional management instead of trying to pick individual BDC winners myself, and have held First Trust Specialty Financial Opportunity Fund (FGB) over many years with good results. With a current distribution of 11.4% that has been steady or risen since 2009, and now back at a discount (-2.7%), I have been buying more recently.
- I've also got a position in mortgage REITs, via two leveraged ETNs - CS X-Links 2X Leveraged Mortgage REIT (REML) and UBS ETRACS Leveraged REIT (MORL). Both yield about 22%, are not for the fainthearted and do not - in my opinion - deserve a major place in one's portfolio. Along with the CLO funds mentioned earlier, and some of the higher yielding MLP funds, these investments that are higher up the risk/reward spectrum can boost our yields, but need to be followed carefully. The main risks for REML and MORL probably involve sharp spikes in interest rates, which I do not foresee. As I mentioned in a recent article, I think the expansive effects of the recent tax bill may be partly offset by an increase in liquidity as tax savings for corporations and the investing class end up back in the financial markets. That may mean that interest rate increases will continue to be very gradual, giving mortgage REITs and their investors' time to absorb and/or manage the increases. We'll see. In the meantime, I'm enjoying the distributions.
- Another recent addition has been Neuberger Berman Real Estate (NRO), a solid entrant in the REIT closed end fund world; good yield of 9.76%, discount of -3.8%. I was under-represented in REITs and felt I needed to create a position, but didn't want to do the picking myself. Same approach as with the BDC world. Let professional managers do it for me.
- Similarly with the closed end fund world. Even though I am obviously comfortable buying and selling closed end funds, I decided having a piece of Rivernorth Opportunities Fund (RIV), managed by one of the top closed end fund strategists in the country, made sense, both for its yield (12.6%) and stand-alone investment opportunity, and as a way to follow closely what it was buying, selling and holding in order to get ideas for my own portfolio. I had been in and out of RIV over the past six months, as the fund's strategy with respect to its recent rights offering raised some temporary questions. (Again, it was LeftBanker who was helpful in explaining - in this article - what was going on both before and after the rights offering.)
Here is a table with my entire portfolio, we go to press:
|Savvy Senior Portfolio 1/3/2018||Symbol||Current Yield||CEF Premium/ Discount||This Holding As % of Portfolio Income||This Holding % of Portfolio Income 1 Quarter Ago||Increase /Decrease as % of Porfolio income||Asset Class|
|Eagle Point Credit Co.||ECC||12.76%||10.84%||10.30%||11.68%||-1.38%||CLO fund|
|Oxford Lane Capital||OXLC||16.12%||3.50%||6.45%||7.59%||-1.14%||CLO fund|
|ETFIS InfraCap MLP ETF||AMZA||24.00%||NA||6.10%||4.45%||1.65%||MLP|
|First Trust Specialty Financial Oppty Fund||FGB||11.40%||-2.69%||5.86%||4.48%||1.38%||BDC|
|Brookfield Real Assets Fund||RA||10.22%||-7.08%||5.67%||3.78%||1.89%||HY|
|Guggenheim Enhanced Equity Income||GPM||10.79%||-1.33%||4.46%||4.68%||-0.22%||Equity Option|
|Voya Global Equity Dividend||IGD||9.45%||-5.95%||4.06%||5.08%||-1.02%||Equity Option|
|Duff & Phelps Select Energy MLP Fund||DSE||15.04%||0.17%||3.98%||3.98%||MLP|
|Virtus Total Return Fund||ZF||11.19%||-4.44%||3.82%||2.93%||0.89%||Eq/Fixed|
|Rivernorth Opportunity Fund||RIV||12.59%||-0.10%||3.59%||3.59%||CEF|
|Neuberger Berman Real Estate||NRO||9.76%||-3.83%||3.52%||1.48%||2.04%||REIT|
|Eaton Vance Tax Mgd Global Div Inc Fund||EXG||9.72%||-1.05%||3.47%||3.64%||-0.17%||Equity Option|
|Pimco High Income Fund||PHK||12.98%||10.19%||3.22%||3.22%||HY|
|Miller/Howard High Income||HIE||11.16%||-0.80%||3.14%||3.68%||-0.55%||Equity/Income|
|CS X-Links 2XLeveraged Mtge REIT||REML||22.00%||NA||2.77%||2.77%||Mtge REIT|
|Allianz Convertible & Income II||NCZ||11.11%||3.85%||2.65%||2.78%||-0.13%||HY/Conv|
|NexPoint Credit Strategy Fund||NHF||9.49%||-4.02%||2.53%||1.92%||0.61%||HY|
|Fiduciary Claymore MLP Oppty||FMO||13.10%||-0.08%||2.43%||3.77%||-1.34%||MLP|
|MFS Intermediate High Income||CIF||9.04%||6.14%||2.41%||3.42%||-1.01%||HY|
|ClearBridge Energy MLP Oppty Fund||EMO||10.85%||3.67%||2.38%||1.78%||0.60%||MLP|
|Allianz Convertible & income||NCV||11.10%||5.40%||2.29%||2.41%||-0.12%||HY/Conv|
|Allianz Diversified Inc. & Conv. Fund||ACV||9.18%||-4.08%||1.95%||2.04%||-0.10%||HY/Conv|
|UBS ETRACS Leveraged REIT||MORL||23.00%||NA||1.83%||3.60%||-1.77%||Mtge REIT|
|Barings Global Short Duration HY Fund||BGH||9.18%||-7.49%||1.75%||1.75%||HY|
|Calamos Conv & High Income||CHY||10.13%||1.8%%||1.66%||1.74%||-0.08%||HY/Conv|
|Calamos Global Dynamic Income Fund||CHW||9.25%||-0.01%||1.57%||5.41%||-3.84%||Equity/Income|
|Calamos Conv Oppty & Income||CHI||10.19%||1.27%%||1.37%||1.44%||-0.07%||HY/Conv|
|Avenue Income Credit Strategies||ACP||10.26%||-6.40%||1.32%||2.92%||-1.60%||HY|
|Macquarie/First Trust Global Infra Fund||MFD||9.65%||-6.26%||1.28%||1.34%||-0.06%||Utility/Infra|
|Gabelli Equity Trust||GAB||10.34%||-4.33%||1.04%||1.04%||Equity|
|Eaton Vance Risk Mgd Diversified Eq Inc||ETJ||9.47%%||-4.46%||0.89%||1.96%||-1.07%||Equity Option|
|Reaves Utility Income Fund||UTG||6.21%||-7.45%||0.24%||0.24%||Utility/Infra|
|Franklin Limited Duration Fund||FTF||10.57%||-3.98%||0.00%||4.12%||-4.12%||HY|
|Kayne Anderson MLP Inv Co||KYN||9.45%||2.04%||0.00%||3.543%||-3.54%||MLP|
|Eaton Vance Managed Div Equity Fd||ETY||8.30%||-1.30%||0.00%||1.68%||-1.68%||Equity Income|
|LMP Capital & Income||SCD||8.89%||-8.82%||0.00%||0.62%||-0.62%||Equity|
Thanks to all my fellow Seeking Alpha authors, for your great ideas and analyses, many of which work their way into my portfolio. Also thank you to my followers, other readers and commenters, for your helpful and supportive feedback. We're all in this together - politically, economically, socially - and I hope this is just another way of all of us helping to make one another a little smarter - and maybe even richer.
Good luck in 2018!
P.S. Some readers have asked me for a breakdown of my portfolio by market value as opposed to income. I usually do not track that, but for those who are interested, I have calculated that information and included it in a blog note, linked here.
Disclosure: I am/we are long ECC, OXLC, AMZA, FGB, RA, GPM, IGD, DSE, ZF, RIV, NRO, EXG, PHK, HIE, REML, NCV, NCZ, NHF, FMO, CIF, EMO, ACV, MORL, BGH, CHY, CHW, CHI, MFD, GAB, ETJ, ACP. 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.