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We Now Have An Idea Of Portfolios Hedged To Higher Rates


  • The first part of this year has been dreadful for some rate-sensitive stocks and sectors.
  • We can assess the funds that have been positioned correctly during the period.
  • Identifying the funds that performed poorly during rising rates and those that have performed well can help us create more durable portfolios.

We now have a perfect illustration as to how funds are positioned for the current rate environment. Our Core Portfolio is exposed to two primary risks: credit and interest rate. Credit risk is the risk that the underlying bond will default and not pay back principal nor interest. Interest rate risk is when rates rise reducing the relative attractiveness of your lower coupon bonds, sending the price lower.

In August of 2016, we implemented a Three Legged Stool strategy in order to combat rising rates. The strategy depended on investing in closed-end funds that hedge their rates (hedged fixed income), shortening durations in Core funds with a focus on short-duration/limited duration funds, as well as floating rate funds which invest in loans that adjust their coupons quarterly. The first two are still in the portfolio while we did advocate removing the floaters early last year as the sector was getting hit from repricings (refinancing) that more than offset the interest rate hedge.

Repricings may be close to running their course. We continue to monitor the space and are seeing some encouraging signs. Look for some more in-depth sector analysis in the near-term.

This is a selection of funds in each category that we follow that have performed well, on a NAV basis, since the start of the year. During that period, interest rates have risen from 2.41% to 2.86%. Additionally, credit spreads, a barometer for credit risk, have widened (meaning more risk) with the high yield spread going from ~350 bps to ~382 bps. If a fund has increased in value since the start of the year, it means that they have an active strategy today that combats both higher rates and wider spreads.

The floating rate sector has performed the best for obvious reasons- they have the least duration of

We construct portfolios that not only take advantage of opportunities in particular funds but also incorporate a top-down analysis of the markets, sectors, and funds themselves to produce diversification benefits reducing risk-adjusted returns. We just issued our March newsletter where we incorporate some of these ideas into our Core Portfolio.

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This article was written by

Alpha Gen Capital profile picture

Alpha Gen Capital is a former financial advisor and his analysis is meant to provide a relatively safer income stream with CEFs and mutual funds. He has been writing about investing on Seeking Alpha for the past decade and he aims to help investors better understand how to properly construct a portfolio.

Alpha Gen Capital leads the investing group Yield Hunting: Alt Inc Opps, where along with his team of analysts, he focuses on closed-end funds and getting yield from bonds to complement dividend portfolios. The service is dedicated to income investors who are searching for yield without the high risk of the equity market. Additionally, they provide 4 actively managed portfolios. Learn more.

Analyst’s Disclosure: I am/we are long FPF, PIM, PGP, ARDC, LDP, PGZ. 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.

The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks mentioned. The strategies discussed are strictly for illustrative and educational purposes and should not be construed as a recommendation to purchase or sell, or an offer to sell or a solicitation of an offer to buy any security. There is no guarantee that any strategies discussed will be effective. The information provided is not intended to be a complete analysis of every material fact respecting any strategy. The examples presented do not take into consideration commissions, tax implications or other transactions costs, which may significantly affect the economic consequences of a given strategy. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any security in particular.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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Comments (27)

Thank you AGC. Nice presentation.
According to CEF Connect, both JFR and JRO have 36% leverage. Higher interest rates would increase leveraging expenses. Maybe that's the reason?

Hopefully an expert will weigh in.

Please note: i don't know anything about analyzing securities. I read articles broker reports and use my intuition and common sense and learn from my mistakes. The world of investing is pretty crazy sometimes.)
Nuveen's two "floaters" (JFR, JRO) just dropped their payout to .062/month each (from .0675 and .0705, respectively), This was a bit of a disappointment, given the steady rise of the 3-month LIBOR, upon which most floating-rate bonds are based. Any insight as to why this counter-intuitive adjustment happened?
Alpha Gen Capital profile picture
This is the repricing effect that i discussed in our floating rate assessment, coupled with higher leverage costs. There is a lag until the funds benefit from higher libor. Most floaters take 90 days. Meanwhile, the fund keeps seeing floaters get called and the new issuance is lower coupon because credit spreads are tighter and libor spreads are lower.
IndyDoc1 profile picture
nice review !
Interesting analysis Alpha Gen —- Gives me food for thought.
PGP hit a high of $26 in 2014 and is now at $14, how does that sound like a good investment?
09 Mar. 2018
Since 7/25/14 (PGP's high) to 3/8/18, on a $10,000 investment, total return for PGP is $14,059 vs. $14,865 for the S&P 500. Not too shabby. TR for AGG, by comparison: $10,660.
Regarding XAI: what is a term trust fund. Been trying to search on that one and am coming up empty. What kind of stuff is it holding?
Alpha Gen Capital profile picture
It just means that it will self liquidate at some point in the future with a targeted return of the NAV at some specified price.
Ok, thanks. Bought a little bit of it to test the waters.
Kelbor Del profile picture
I love it when an article praises some of my holdings. This one does. Thank you for the good report.
Watch out for confirmation bias :-)
Any reason why DMO was left off of your High Yield chart? Well-researched piece, thanks.
Alpha Gen Capital profile picture
DMO falls into the mortgage category which I didn't include (but should have). I'm not a fan given the large premium and the fact that its a term fund set to liquidate in 4 years.
Thanks for the article.
Cynical Rhino profile picture
No longer long PCI/PDI based on your disclosure?
Alpha Gen Capital profile picture
We are. But it wasn't a fund "linked" in the text of the report so it didn't appear. Sorry about that.
Very good analysis. Thank you for posting it. Mark Grant made an interesting observation today on SA where he feels rate might not move that much higher this year due to the EU keeping interest rates low for longer thanks to political uncertainty in Italy and Germany.
Triple F Fred profile picture
thanks again AG... very much appreciate your updates and lucid commentary.

You have BIT and BTZ classified as "Hedged Fixed Income" in the Google Sheets just like PCI/PDI. The BIT/BTZ durations are shorter than PCI/PDI but their NAVs seem to have suffered the increase in rates. Is their hedging ineffective or are other factor at play?
Alpha Gen Capital profile picture
Very small hedges compared to PCI/PDI and mostly on the short end to hedge rising leverage costs.
As I study the history of FPF, I see that the discount was between 6% and 12% back in 2013-15, exceeding 10% for 3 periods in that timeframe.

Would not combo of fed balance sheet reduction and increased US Govt debt risk the same (or greater) FPF discount over the next couple of years?
fabulous tables..
Lawrence J. Kramer profile picture
These are very useful lists and observations.
rfied112 profile picture
Very nice presentation...holding ldp and fpf.....may dip into fpf today if it drops enough
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