Retirement Income (Part 3): Here Is How I Am Building My Retirement Income Fund

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Includes: BHK, ISD, JQC, OCSI, PPR, WIA
by: The Owl
Summary

Part 1 of this series covered the current interest rate environment, a transition to rising interest rates, as this impacts significantly investments being made today which will be held long-term.

Part 2 of this series identified those types of investments, often used by retirees to generate "safe" income, whose capital value will likely be negatively impacted by rising interest rates.

Given the author's decision to put interest risk avoidance at the center of the retirement investment strategy, many investment options frequently used to secure retirement income must be excluded.

This article, Part 3 of this series, covers the investments that the author is making or am considering making to build a Retirement Income Portfolio that maximizes income while preserving capital as rates rise.

As these income investments are being made as we transition from declining to rising rates, a hedging approach to mitigate timing risk of these investments is also discussed.

I. Key Principles and Decisions on Which This Portfolio Is Based:

  1. Create a "buy and hold" portfolio that does not require frequent attention.
  2. Create income exclusively, avoiding a reliance on capital appreciation for any portion of the return.
  3. Focus on avoidance of capital impairment through interest rate-maturity-duration risk.
  4. Accept that Decision 3 leaves a choice between accepting default risk or lower return, balancing those elements carefully
  5. Use as a design basis the premise, even as, we are near interest rate lows, that we have moved past the low points of interest rates across the duration spectrum and will move steadily higher for decades.
  6. After completion of the portfolio, pressure test the portfolio against Decision 5 to evaluate the beta error of the impact of the alternative thesis (low interest rates forever) to look at downside impact.

Discussion of these principles and decisions was covered earlier in this series of articles. A view of the interest rate environment, a transition from a secular period of declining rates to one of rising rates, was reviewed. A discussion of the impact of this transition to rising rates on current investment decisions followed. The critical issue rising from the discussion is that "traditionally safe", commonly used instruments to provide for retirement income must now be excluded or minimized to avoid capital impairment. This article will cover the remaining viable investment options left, in the opinion of the author, and select from those to identify how to create retirement income while avoiding capital impairment in a “buy and hold” account for the next thirty years

If you played team sports and you remember how your coaches developed game plans, you will recall that a frequent strategy of your coaches was to avoid letting the best player on the other team dominate the game and beat you. Plans would be developed to force your opponent to beat you with their less talented athletes while attempting to secure victory by exploiting your team's strong points. That is, you ensured that the "greatest risk" to you would be neutralized to the maximum extent possible, thereby exposing your team to the next greatest, but lesser, risk or risks.

So it is with this portfolio design: as I thought about what I believed the greatest risk in the future, the current position in the interest rate cycle loomed very large in my thinking, rightly or wrongly. I have made a very deliberate, conscious decision to focus on that risk to prevent that “greatest risk” from resulting in a substantial future loss of income, and impairment of capital or both. I have made a deliberate choice that I will not get hurt financially by rising interest rates. The case for rising rates was made in Part 1 of this series (found here).

Of course, this means that I can be hurt by something else. This decision has consequences as the decision does not eliminate risk, it only shifts the risks to those perceived by the author as less sinister. This single decision excludes many options typically used in retirement accounts over the past half-century or more, as discussed in Part 2 of this series (found here). In turn, this leaves many fewer options left for investments, itself creating a risk; as well, it requires the investor to balance and decide between the remaining risks, default and market risks, and lower income. Typically, taking lower risks would typically connote receiving less income.

Final Points Prior to Discussing Portfolio Composition:

  • Use this discussion to provide “food for thought” in developing or modifying a retirement income fund rather than following these recommendations blindly and mechanically. Let me be clear: this is what I have done and am doing to build my retirement income fund, offering specific investments that work for me. Even as I am very confident that this approach will work for me, however, other investors may well fell more comfortable with adjustments to the ratios of the three asset classes discussed or even may wish to utilize different investments to accomplish a similar goal. This is what I am doing, but may well not work exactly as positioned for everyone nor does it necessarily need to be.
  • Diversify over time. I have been slowly building and buying the funds discussed for nearly a year to dollar-average into these positions. While I am not expecting to get the best prices ever for any of these investments, I aspire to secure reasonable prices for each and hope to avoid high prices rather than seeking low prices on the invested funds. At this point, as stated elsewhere, I might choose to substitute other alternatives for some of the selections made here (e.g., STWD which has moved up significantly since its purchase in 2017) if I were making them today.
  • Select the optimal funds at the time of investment and do not blindly follow my specific selections. There are many reasonable substitutions that can be made for my selections, and given that I made some of these selections earlier, there may not be similar securities which may be more timely than the ones listed (because of a bigger discount to NAV or a higher yield). In some cases, I will provide resources that can help with alternative substitutions.
  • I had originally targeted a 6.5% yield in a 6-7% range. As I have optimized the balance of risks versus income, I found that my decisions are guiding down both risk and income so that is headed for the lower end of the range, at about 6.3% (currently at 6.15% with the investments that I own, excluding the cash portion which remains to be invested). I still expect to secure a 6+% yield on the portfolio, excluding the impact of any future short-term rate increases which are anticipated to be made by the Federal Reserve Bank.
  • (Author's Note: as I finalize the article, Eaton Vance has announced an increase in the distribution for one of the funds below, Senior Income Trust, increasing it from $0.031 monthly per share to $0.032 monthly per share. The discussion refers to the old distribution rate).

II. Overall Composition of the Fund:

This fund is composed of three elements: Loans, Lending and Lead (as in portfolio ballast). Loans and Lending are self-explanatory while “Lead” may require an explanation. The “Lead” reference, in addition to maintaining the alliteration, refers to the lead ballast placed in the bottom of ships to keep them more stable in stormy seas and the “Lead” here is intended to do the same thing. Seemingly contradictory, I have set aside about 25% of the portfolio to invest at odds with the underlying logic of the majority of the portfolio. That is, I am investing a portion of these funds at this time using a completely different thesis. Why? Because one can be either wrong about the underlying basis or, more likely, may be early. One may be right in the long run but very wrong in the short run. The “Lead” portion of the portfolio provides some “ballast” against being wrong or early as well as providing some additional hedging.

Here is my current target portfolio, with those funds already obtained in normal text and those being considered for future purchase in italicized text (with no assurance that these will be ultimately used as evaluations have not yet been done):

Income 3 (Chart created by author using the most recent distributions annualized and market data as of the close on July 3rd, 2018)

III. “Loans”:

As the reader can see, the "Loans" portion of the portfolio represents the core of the portfolio, with a target of 50% of the investment made up of closed end loan participation and floating rate funds. According to Nuveen, bank loan funds offer "enhanced portfolio diversification and reduced risk due to historically low correlation with equities and investment grade corporate bonds". As I have already argued in Part 1 that both equities and investment grade bonds are in for a rough ride over the next two to three decades, a historically low correlation with those two investment areas expected by the author to struggle would therefore be viewed as a positive.

Loan participation CEFs have a good history of steady, reliable and unspectacular income. This should mean that they have relatively stable market prices, but one doesn’t necessarily find that when one looks back far enough. At the present time, I have included in the portfolio the Eaton Vance Senior Income Trust (NYSE:EVF), the Voya Prime Rate Trust (PPR) and the Nuveen Credit Strategies Income Trust (JQC). In the next graph, please find a graph of market prices for three CEFs, two back to Jan 1999 (EVF, PPR) and the other (NYSE:JQC) back to inception, late 2003, with the price at the close of July 3rd set at 100%:

(Chart produced by the author using data obtained from Yahoo Finance and from Investment Fund websites responsible for the Funds discussed)

In this graph, market prices of the three funds are shown benchmarked against the closing price of each fund at the close of July 3rd, 2018, fixed at 100%. Clearly, over this period, there has been some volatility, more than one might want in a retirement income fund. One needs to consider that this data covers two decades, during which time much happened.

The most obvious concern about market pricing occurs during the period of the 2008 financial crisis, a potential existential threat for bank loans as it was a banking crisis. However, one also finds that the fund’s market values recover quickly, within the year, from the levels just prior to the crisis and that the values of these funds have been relatively stable for the last decade since that point.

However, the market pricing was down from early in that decade and we need to understand why. Fear of failure and bank loan default could have contributed to the decline of market prices of these funds, of course. However, I believe the major contributor for value fluctuation of these funds is this:

(chart generated by the author using data obtained from the following website: United States Prime Rate History)

This is a chart of the three-month LIBOR rate which is the primary benchmark rate for most of the loans in these funds. Superimposition of this chart on the market value chart and one sees a broad correlation of the underlying benchmark rate with the market values of these funds. The first obvious observation is that LIBOR rates in the early part of the decade, at which time market prices were much higher, and again just prior to the crisis, were much higher than those since 2008. It should not be surprising that an vehicle providing value through income would not decline to the same extent as the income itself. In broad strokes, with some lag time for the impact of changes on the benchmark rates to flow through, the market valuation of these funds are largely determined by the underlying benchmark LIBOR rate. The benchmark is the determining factor in the income of these funds (represented by EVF and PPR) as shown here:

(Chart produced by the author using data obtained from Yahoo Finance and from Investment Fund websites responsible for the Funds discussed)

Again, superimposition of this income from these representative funds with the underlying benchmark rate on which they depend and one sees an unsurprising broad correlation, again factoring in an apparent lag for the impact of benchmark changes to flow through to income. Market prices are down because the income provided by these securities is also down significantly.

However, there does not appear to be an absolute correlation and there appear to be other factors contributing to greater or less income relative to the benchmark. The reader can find below the spreads of fund income for EVF and PPR over LIBOR over the entire 20 year period for two of the three funds (EVF and PPR):

(Chart produced by the author using data obtained from Yahoo Finance and from Investment Fund websites responsible for the Funds discussed)

While the income from these funds appear to track the underlying benchmark rates as they should, the spreads over the benchmark rates do appear to vary somewhat over time, based upon this chart. Indeed, the spreads seem to widen in periods when the rates are declining (e.g., 200-2002, 2008-2009) and compressing (2003-2007 and 2014-now) which can possibly be traced back to the loan terms (how much spread the originating creditor is able to secure when making the loan). Again, there also appears to me to be some lag between a change in rates and the “flow through” of that rate increase to income as instantaneously offered by the fund to the fund owners. Be that as it may, the current spread is not at the lows, but appears to be lower than average, suggesting that the market pricing of these securities is not too high.

Most of that variability occurred at or prior to the 2008 period. Over the past decade, spreads on bank loans have remained relatively constant (until recently) at about 2.5-3%. Recently, they dropped to a near 1%, again demonstrating the compression occurring coincidentally as benchmark rates reset higher. If the funds follow the historical pattern, however, the fund income will catch up and may even overshoot as benchmark increases moderate or reverse. In addition, recent spread compression will be offset by increasing benchmark rates and should also move back towards the mean as the higher benchmark rate results in higher net interest income for the loans to be used for increasing of distributions.

Overall, the combination of the relative safety of bank loans (secured, high position in the capital structure) combined with substantial diversification (individual loans typically represent less than 1% of a fund’s assets and cover a wide number of economic sectors) contribute towards minimizing the risk of owning these assets. While they are not “riskless” like T-Bills, the incremental risk of these funds relative to the riskless T-Bills are more than compensated by a near 4% coupon advantage of these funds (using the average of the three funds selected of 5.67%) relative to the T-Bills yield of 1.85%.

Before closing, there are few additional points that merit attention.

The first is related to the risk management approach used here and concern around concentrating too many assets at a single investment manager. If one looks at the market-pricing of the three funds shown above, one would see the move in the fund’s market pricing to be highly correlated, appearing to move together in a highly synchronous way. So why would I choose so many funds and not concentrate on just a couple? The answer is that part of the risk management strategy employed here is what one might call “over-diversification”. I have not only picked a number of funds for this and the other categories, but note that I have systematically used different fund management companies. This is not accidental.

I have a fear, probably overblown as generals always fight the last war, that a fund management company will develop “blind spots” in their risk management approach, resulting in significant losses in funds which ought to be relatively stable. To prevent this, I don’t want to put too much of my capital into any one organization’s hands. Using this approach, this also ensures that there will be literally hundreds of loans making up the "Loans" portion of my retirement fund. Individual failures ought not result in significant impairment of my funds and only a widespread, massive failure of the sector as a whole could severely impact the fund’s value. The downside is that I have a couple more funds to follow, whereas the upside is that I may be able to blunt the impact of a key failure mode, the breakdown of the risk management protocol at any given fund which will not be easily foreseen. This may be an exaggerated concern, but the downside of doing this is more easily managed than the downside of not doing it.

The second point concerns comments made to earlier articles in this series. Some commentators were expressing concern about distributions representing funds other than those actually being earned, especially Return of Capital (NYSE:ROC) being used to flatter distributions (to use James Grant’s term). In checking back through the funds that I have considered, essentially all of the income over the past decade or so has been derived from interest income from loans. Out of the income from the past 15 years, I found only 1 cent of ROC for PPR and 11 cents of ROC for JQC, both stemming from the 2008 period. These amounts represent a tiny fraction of the distributions made over the past two decades and ROC has not been utilized for these funds in nearly a decade. It does not appear that ROC represents a significant percentage of distributions from these funds as they might from other types of CEFs.

One final point concerns the three Bank Loan Participation CEFs have already been selected for inclusion in the portfolio and positions already established (JQC, EVF and PPR). I have also indicated consideration of inclusion of AFT and BGX, but have not investigated those funds specifically and have made absolutely no decision to include them or not. Their primary virtue at this point is that they are from fund managers not otherwise used elsewhere in the portfolio, consistent with the “over-diversification” principle. They represent my best (and actual) placeholders that I am using in the portfolio design. Upon evaluation, however, I may or may not use them and may well substitute other funds for those.

In closing, I will be using Bank Loan Participation/Floating Rate Funds (i.e., Bank Loans) to represent a full 50% of the assets of my retirement income account based upon the combination of their lack of sensitivity to interest rate/maturity/duration risk (my primary concern), moderated default risk and attractive income with to higher income as rates rise. If rates do not rise, the income remains reasonably constant, so these investments look attractive in a world with a very uncertain future.

Key Takeaways:

  • Bank Loan Participation CEFs are funds owning predominantly senior secured debt at the top of the capital structure, built upon a hundred or more individual loans where each represents a small fraction of the total value and representing many sectors across the economy, presenting a relatively low (but not zero) risk of default compared to many other investment options at lower levels in the capital structure (especially equities).
  • Bank Loan Participation Fund and Floating Rate CEFs appeared to have held up well in the midst of a crisis that should have proved to be an existential threat and recovered quickly thereafter, providing income throughout the entire period.
  • These funds moot interest rate-maturity-duration risk as they are created from greater than 80% floating rate loans, addressing the primary risk as identified in earlier articles in this series.
  • These funds appear to have currently a relatively low valuations relative to historic levels (i.e., low spread of funds income over the benchmark rate), even as benchmark rates appear to be moving higher. At a minimum, this combination should provide a stable and growing income stream with a stability of long-term capital value.

IV. "Lending":

In the portfolio shown above, a “barbell” approach is being used in the portfolio design and this category represents the riskier end (even if I don’t view it as particularly risky) of the portfolio “barbell”. The intent of the “Lending” investments is to mix income vehicles with incrementally higher yields than Bank Loans but retain the insensitivity to interest rate risk exhibited by them through their being levered to short-term benchmark rates. As discussed above, this leaves the investor balancing default and market risk with income level, so a challenge with this approach revolves around balancing higher income while mitigating impairment. To help with risk, “over-diversification” is used in the design to minimize the negative impact of single security event risks resulting in impairment. Beyond that, however, these investment selections required some “help”, as described below, and I would recommend that investors get “help” if any investments like this are being considered in a portfolio where the investor is especially concerned around capital impairment.

The areas chosen for investigation included:

  • Commercial Real Estate, Business Development and Specialty Finance Lenders, active lenders who are growing their loan portfolio, typically structured as floating rate loans and
  • Short- to intermediate-duration portfolios of bonds, which are less vulnerable to interest rate risk due to short maturities rather than floating rates.

Four investments were selected for this category, as the reader can see in the table above:

A. PGIM Short Duration High Yield (ISD) was the single selection made which holds short-duration instruments. The short-duration contributes two advantages:

i. The short duration moots largely any interest-rate risk, as discussed, and

ii. The short-duration represents the lower-risk end of high yield, so while the yields may not be as strong as longer-duration portfolios, but the holding time limits exposure to any given investment (average maturity of 3.8 years)

The fund holds about 190 positions, so each position represents about 0.5% of the assets of the fund, so a single security event will not represent a major impairment for the fund. While there were competing CEFs of this type, the “over-diversification” principle suggested that this fund be chosen in lieu of other funds having other investment managers from which I had already selected. In addition, I had owned the sister fund, the Global Short Duration High Yield fund for an extended period and was satisfied with the performance of that fund. For this purpose, I made a conscious decision to invest in dollar-only assets as the fund was being built, leaving for a later point a decision around diversifying on currency. As such, I opted for the dollar-centered fund (NYSE:ISD) in lieu of the Global Fund (NYSE:GHY). In addition, a number of the Bank Loan CEFs also hold a minority position (up to 15%) of non-dollar loans, so there was already in place some currency diversification.

Of course, if you don't like the short-duration funds, make one yourself. Create a ladder of bonds out to 5-8 years, with the ladder steps equally spaced, buy those bonds and clip the coupons, replacing them with the longest maturity of your ladder as they mature. If you use this approach, the ladder must be maintained with discipline.

B. Oaktree Capital Strategic Income (OCSI):

Oaktree Capital Strategic Income Fund is a Specialty Finance Company that was secured in the Oaktree Capital Purchase of Fifth Street Finance in October 2017. It had formerly been managed by Fifth Street Finance as the Fifth Street Finance Floating Rate fund (FSFR), having mixed success.

This fund has a very limited track record and acquiring this fund is a departure from my normal framework of analysis. It is a testament to my faith in Oaktree Capital to do an outstanding job of credit analysis and selection that I am adding it here without the ability to do much analysis on it.

This may not be (close to) sufficient analysis for you, so there are some Seeking Alpha contributors from whom you can get other recommended securities to fill this spot. BDC Buzz writes extensively on Business Development and Specialty Finance companies and I follow his work closely (most recent article here: 8.6% Yield With Dividend Growth Potential Through Reduced Fees And Increased Leverage) and his most recent article on Goldman Sachs BDC (NYSE:GSBD) would be a very good replacement for OCSI. Achilles Research would be another contributor “with whom to consult” on these types of investments, has also written about GSBD (here) and is an excellent source for identifying solid investments for income. A third contributor who does excellent analytical work in this area as well as mortgage REITs (mREITS) is Scott Kennedy, who recently wrote an article (here) on another BDC that I would consider, MAIN Capital (also covered by Achilles Research here).

C. Commercial Real Estate Lenders: Starwood Property Trust (NYSE:STWD) and Blackstone Mortgage Trust (NYSE:BXMT):

I have included two companies involved in Commercial Real Estate Lending, even if one (STWD) is not a pure play on lending with only about 56% of their assets in commercial lending, about 5% of their assets in residential lending, 25% of their assets invested in property and the remaining focused on servicing of loans and other associated activities.

In contrast, Blackstone Mortgage Trust is a “pure play” commercial real estate lender.

Rather than repeat what others have covered, I refer you to articles by prominent Seeking Alpha contributors. Achilles Research, also cited above, has also written articles on STWD (here) and BXMT (here). Well known real estate contributor Mr. Brad Thomas has also written recent articles on STWD (here), who actually has a HOLD not a BUY on STWD as he does not like the complexity, and BXMT (here). While Mr. Thomas and I have not always agreed on which REITs constitute a "good investment", he is extremely knowledgeable about real estate as well as the credit complex around real estate. Both of these authors make a compelling case for one of these names with one of the two making a compelling case for the other.

There exist yet other "Lenders" who offer yields disproportionate to the risks being taken and Seeking Alpha readers have an abundance of contributors who are looking for the best ones for you. If the reader is uncomfortable with these specific names, there are other options within these same areas with which you may feel more comfortable. These are the ones that work for me in these percentages.

We started this section with a comment that this is the riskiest end of the portfolio. Some readers may not like the specific recommendations, but other readers may believe that devoting 25% to the riskier end of the portfolio is not something they want to do. There are two options to address:

i. Simply reduce the percentage of "Lending" and sacrifice a bit of yield, or

ii. Reduce the percentage of "Lending" and reduce a comparable amount of hedging in the following "Lead" category covered next to maintain income, leaving more to the "Loans" area.

While I believe that the components of this part of my target portfolio offer yields disproportionate to their risk in aggregate while providing a manageable risk (and therefore are targeting my investments this way), I also recognize that some readers may be uncomfortable with this approach. I do believe that the barbell approach taken here will deliver higher returns for a given total amount of risk taken, but this may not be for everyone.

However I encourage the reader to consider use of securities in these sectors as I believe they offer, at this point, yields more than offsetting the risk with the ability to secure yet higher income as rates rise. The specific names selected are not critical issue her (other than you pick good ones). What is critical is that one selects relatively strong income largely levered to rising rates by a predominantly variable rate lending portfolio or else strong income from limited duration lending which can be turned over at ever higher rates.

V. "Lead":

"Lead" here refers to the element, the very heavy metal placed in the bottom of ships as ballast to help ensure that they stay upright in stormy seas, which I expect to experience "stormy financial seas" in my retirement even as I cannot be sure that this will happen.

Inclusion of hedging “ballast” was not part of my original plans, but developed over time as I became concerned around the narrowing number of investment options that I had left myself, having eliminated most investing options as described in Part 2. Given my views around fixed income, municipal bonds and equities in general as articulated earlier, there remained a much narrower set of options that drove more concentrated positions in fewer, specific sectors (and none in most others). All other things being equal, this would typically increase risk which was exactly what I was trying to reduce.

I believe that the arguments for rising interest rates, made in this series of articles, in the intermediate future is sound and I am acting upon those arguments. Of course, no one ever made investment decisions thinking that they were wrong either, yet many people lose money for precisely that reason. Given the importance of these funds to future quality of life, retirees are likely to be more risk-averse than others and I am no different. For this reason, I decided to add a "ballast" portion to the portfolio.

As discussed above, given my orientation as described in Part 1 of this series, I had originally planned to go "all in" for this portfolio, incorporating ONLY those investments that I thought would do well in rising rates. As I considered risk management, however, I thought that I could be early in moving to these investments. Therefore, the "Lead" ballast investments are precisely those investments that I would recommend avoiding in general. Then, if I am early, any hits to the remainder of the portfolio might be offset by the "Lead" investments doing well.

There was one hedging investment that I planned to add from the very beginning; specifically, this was the Western Asset Inflation-Linked Asset Fund (WIA). There is a possibility that we could experience a rise in inflation that exceeded the rate of increase of variable rates and a portion of the portfolio devoted to this fund (which I had made early in the process) would help to offset this risk. Composed of 80% inflation-linked investments, including three-fourths of that 80% (i.e., 60% of the total portfolio) being government debt ("TIPS"), this fund is actually levered to inflation rather than to short-term rates per se. This is the one hedging investment that I expect to keep for the long-term; while it represents a drag on income, it provides hedging for inflation and it provides a bit of hedging for a "risk off" scenario where investors head for the "safe harbors" of US Treasury debt.

My current use of VRP, the Variable Rate Preferred ETF, is as a provider of largely fixed income. In spite of the name, an evaluation of the components does not suggest to me the degree of variability that one might have expected. This component is simply providing some income which should continue to support the income level until rates rise. As that happens, I will likely be selling this component to fund additional purchases of those names more levered to rising rates; until that happens, I will continue to get reliable income from a non-municipal bond source and higher than I would get from US Treasury debt.

As I was building the portfolio, I was planning to use either the BlackRock Core Bond fund (BHK) or one to two residential mortgage REITs as another component for the "ballast hedge" category. I used the Core Bond fund as a placeholder in the portfolio as it has the lower coupon and I did not want to boost the income without having made a commitment to those higher yielding investments, unreasonably boosting and exaggerating the income of the portfolio as a whole. I have not yet made a decision on which to use and noted that in the table by italicizing BHK.

In either case, the funds will take a hit to their book value by virtue of rising rates pressing down the value of fixed income securities. Of course, the remaining 75% of the portfolio will be helped substantially by those same rising rates and very likely will offset the fixed income losses several fold over. If those rates do not appear for a substantial amount of time, the high rates offered by the longer-maturity debt, whether Core Bond or mortgage interest, will sustain a higher income for that period.

However, after I published Part 2 of this series, there was some very thoughtful criticism of my avoidance of equities in this portfolio. I had shown that income securities ("Dividend Aristocrats", a subset of the equities market) would likely be under pressure and I was eschewing those securities which I believed would be the focus of retirees seeking income. However, the counterargument made in a very thoughtful way was that the S&P as a whole had historically done extremely well in declining rate periods, but was also delivering positive (if less impressive to underwhelming, but still positive) returns in rising rate periods. The outcome of this observation is that another potential hedge for portfolio value support, if not for income, is the simple inclusion of a S&P surrogate like SPY in the portfolio. If rates rise, as with other hedge investments, SPY will likely fall but will be more than compensated by strong gains by the other investments levered to those rising rates. If they fall or stay even, lackluster performance by the main investments in this portfolio can be stabilized by continued faster gains (over a longer period of time) for the SPY component. I am not recommending this approach and I won't be using it personally, but I understand the logic of this argument. The observation about use of SPY (includes growth investments not included in the income investments that I had premised retirees to use to be income) as a potential hedge may appeal to many and I offer it as an option, if not a personal recommendation, for the reader to consider.

It may seem contradictory to propose part of a portfolio to be created which is completely at odds with the core thesis of the portfolio itself. However, we live in an uncertain world and major transition points are difficult to identify as one is moving through them (one learning from "81-'82). As such, while I have a primary thesis on what I believe the basis of this portfolio design should be, I am hedging my bets by holding some contrary investments and holding some cash to invest later, dollar averaging in over time. It will reduce the upside but, more importantly, it will cushion the downside if this thesis is wrong or too early.

VI. Summary and Conclusions:

Over the past three articles, the looming rising interest rate environment has been discussed (Part 1) along with the potential impact of this environment on "traditional retirement investments" (Part 2) and an alternative investment approach to meeting the retirement income challenge (this article - Part 3). The central thesis of this series is to develop a portfolio which is levered to rising rates to protect capital while capturing ever higher income from those same rising rates. In doing so, we have also discussed several risk management approaches: avoiding an over-reliance on any one fund or an one investment management company, diversification of investments to include the safer end of the capital structure (Bank Loans), and use of "Lead" or "ballast" hedges to mitigate risks of being early or wrong. You may have heard that past performance is no guarantee of future returns, but given the change in the interest rate environment that has come or is coming, this line is especially true at this juncture.

This site is called "Seeking Alpha", not "Delivering Alpha". Any success of this series of articles will not be whether investors rush out and blindly buy what I am buying. Rather, my aspiration for writing this series of articles was to prompt reflection on how portfolios are positioned (even as I am going through the same exercise), provoke consideration of tools that might not have been considered before reading this series of articles and seek new answers for their investment questions. Some readers may re-orient their portfolios to rising rates, but others may choose to use Bank Loans or CRE Lending as a tactic to hedge their portfolio more oriented around a premise of continued declining/low rates. My hope in writing this series is that retirement investors think about how their portfolio is positioned, consider whether that is or is not the best approach and make pro-active, thoughtful decisions about portfolio strategy, whether or not they have agreed with any points made.

It is your retirement.

Disclaimer: No guarantees or representations are made. The Owl is not a registered investment adviser and does not provide specific investment advice. The information is for informational purposes only. You should always consult an investment adviser.

Disclosure: I am/we are long EVF, PPR, JQC, WIA, ISD, STWD, BXMT,OCSI,VRP. 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.