The 8% Income Portfolio: Durable Income In Good Times And Bad - Mid-Year Review

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Includes: ARCC, BBN, BND, CEFL, DNP, EFA, GBAB, GOF, HQH, KYN, MAIN, NBB, NLY, NMZ, PCI, PDI, PFF, RFI, RNP, STK, UTF, VTI
by: Financially Free Investor
Summary

Mid-year review of 8% Income Portfolio.

The portfolio continues to perform well and generate high levels of income, irrespective of a tough environment for income securities.

Updates on recent buys, dividends collected, overall performance.

As usual, we will compare the performance with a traditional 60:40 stock/bond portfolio.

We generally advocate a 3 or 4 bucket diversified portfolio. This "8% Income Portfolio" represents one of the very important buckets in our overall investment strategy. This portfolio takes most of the risk while providing most of the income in our otherwise conservative strategy. If this income strategy is used as part of an overall strategy, we consider it appropriate for most retirees and near-retirees as well as younger investors. As it is true in all areas of life, one should pay attention to the right proportions. How much is appropriate for an individual? It would depend on the individual's goals, risk-tolerance, and personal situation.

This income-centric portfolio was launched in October of 2014 with two simple goals. The primary goal of this portfolio was to provide roughly an 8% income while preserving the capital. The secondary goal was to provide some capital appreciation over the long term (please see full disclosure at the end of the article). Since then, we have provided regular updates on the progress and performance of this portfolio on SA. You can read our original article here. You could also search for all the updates on our ‘ Profile’ page.

True to its name, the portfolio continues to generate high income, thus meeting its primary goal, while protecting the capital and providing some capital appreciation as well in-spite of the headwinds in 2018. For income-producing securities, 2018 has been a difficult year, due to a rising interest-rate environment. Secondly, the overall market has been quite volatile since February this year and markets are still struggling to get to the highs achieved on 26th January 2018.

Some background:

Here is some brief background for the new readers. A total amount of $100,000 was initially allocated to the portfolio, and another $100,000 was contributed in the next 12 months ($8,333 in 12 installments). No more fresh money was added thereafter.

Cash added/contributed:

Initial Investment 10/17/2014:

$100,000

From Nov. 1st, 2014

until Oct 1st, 2015

$100,000

12 installments of $8333.33

TOTAL Contribution

(Cost basis)

$200,000

The primary goal of this portfolio was providing a durable income in good times and bad. The investment strategy was to utilize CEFs (closed-end funds), which generally use some amount of leverage to generate high distributions. To start with, initially, we had chosen to invest in as many as 13 funds (11 CEFs, one ETN and one ETF) to provide us a broad diversification, high distributions, and exposure to different types of assets such as equity, bonds/credit securities, utility, infrastructure, energy MLPs, preferred income, floating-rate income, technology sector, healthcare etc. Subsequently, during the following years, we have added three individual company stocks to the portfolio from the BDC/mREIT sectors. However, altogether, they form less than 10% of the portfolio size.

Here is the current portfolio consisting of 16 securities:

Fund/Stock Name

SYMBOL

Fund's composition

1

DNP Select Income (NYSE: DNP)

DNP

Utility (80%)

2

Kayne Anderson MLP (NYSE: KYN)

KYN

(MLP - Master Limited Partnership)

3

Guggenheim Strategic Opp Fund (NYSE: GOF)

GOF

Equity CEF fund

4

Columbia Seligman Premium Tech Growth (NYSE: STK)

STK

Equity CEF fund

5

Nuveen Muni High Inc Opp (NYSEMKT: NMZ)

NMZ

Muni Tax-Free ( Tax-free yield)

6

PIMCO Dynamic Credit Income (NYSE: PCI)

PCI

Global Income, including corporate debt, mortgage-related and other asset-backed securities

7

PIMCO DYNAMIC INCOME FD (NYSE: PDI)

PDI

Debt obligations and other income-producing securities

8

ISHARES US PREFERRED STOCK ** ETF **

(NYSEARCA: PFF)

PFF

Preferreds 90% (This is an ETF, not CEF)

9

COHEN & STEERS TOTAL RETURN REALITY Fund (NYSE: RFI)

RFI

REIT (Real Estate) CEF

10

COHEN & STEERS REIT & Preferred Income Fund (NYSE: RNP)

RNP

Preferred is 48%, 50% REIT

11

Cohen & Steers Infrastructure (NYSE: UTF)

UTF

Utility+Infrastructure (50% is International)

12

UBS ETRACS Monthly Pay 2xLeveraged ETN (NYSEARCA: CEFL)

CEFL

Exchange Traded Note (based on the index of CEFs)

13

Tekla Healthcare Investors ( HQH)

HQH

Healthcare/Biotechnology

14

Annaly Capital Management, Inc (NYSE: NLY)

NLY

mREIT

15

Main Street Capital Corp (NYSE: MAIN)

MAIN

BDC (Business Development Co)

16

Ares Capital Corp ( ARCC)

ARCC

BDC

Sale/Purchases made since January 2018:

We made some opportunistic buys in the last quarter, reducing our cash reserve and increasing the income.

Symbol

Buy/Sell and Date

Shares and

price

Amount

KYN

Buy

4/9/2018

120

$16.60

$1,992.00

HQH

Buy

4/9/2018

192

$20.75

$3,984.00

NLY

Buy

5/16/2018

145

$10.34

1499.30

NMZ

Buy

5/16/2018

241

$12.44

2998.04

PFF

Buy

5/16/2018

81

$36.93

2991.33

ARCC

Buy

5/16/2018

90

$16.54

1488.60

Few Notes On The Current Composition

MAIN, NLY, and ARCC: Three Individual Stocks

MAIN, NLY, and ARCC are the only three individual company securities in this portfolio, which are not funds (every other security is a fund). MAIN and ARCC are in the BDC sector, whereas NLY is a mREIT. ARCC was added in 2017. All three put together form only 8.67% of the portfolio value.

CEFL:

This is an ETN (exchange-traded note) sponsored by UBS ETRACS and is linked to the 2x leveraged performance of the underlying 'ISE High Income Index.' We have not invested any new money in this security since mid-2015. If you were to look at it only from the price-performance point of view, you would find its performance to be disappointing. But that is just half the picture. Since this is a 2x leveraged product and provides hefty dividends normally in the range of 17-20%, after adding the dividends, it has performed quite well, providing roughly 27.74% gain on the invested capital when we include the dividends compared to -23.19% loss without including dividends. Even though it has performed well for our portfolio, this is still high-risk security; that’s why we have limited our position to under 3.0% of the portfolio size. That said, we intend to hold our current position and may add more at an opportune time. We like to caution that there are additional risks that come with an ETN product, which the investor should be aware of. They are widely discussed in many other articles on the SA forum.

HQH:

Tekla Healthcare is the only fund from the healthcare sector in our portfolio. The fund has a good past record. Even though the fund has struggled in recent times, the long-term future looks bright given the tailwinds to the healthcare sector.

PFF:

PFF is an ETF (not a CEF) and uses no leverage. It has over $16 Billion in assets and provides a broad and diversified portfolio of Preferred securities., The fund caps any single issuer’s weight at 10%, to limit concentration risk. PFF charges a competitive fee.

DNP, UTF:

These two funds overlap each other to some extent. DNP invests in the Utility sector, whereas UTF invests both in Utility and Infrastructure sectors.

GOF:

The Fund invests in US Government and agency issued fixed income debt and senior equity securities, corporate bonds, mortgage, and asset-backed securities. It also utilizes an options strategy. The fund carries a premium most of the time and currently yields 9.8%.

STK:

STK is an equity CEF and invests primarily in the technology sector. The fund currently yields 8.5%. Even though the fund deploys options strategy, however, most of the distributions come from capital gains. The fund is somewhat risky but can also provide high growth in good times. Due to the large appreciation since we invested, the fund is just under 5% of our portfolio.

RFI, RNP:

Both RNP and RFI are from Cohen & Steers fund family and have some overlap in the types of securities they invest in. RNP is a sort of hybrid fund, which invests roughly 50% in real estate (REITs) and rest 50% in Preferred and debt securities. It also provides some exposure to international preferred securities as an added benefit.

RFI is invested in equities of real estate securities. It also invests roughly 15% in the preferred securities issued by the real estate companies.

Both funds have a solid history, provide decent yields and relatively low expense ratio. RFI does not use leverage, whereas RNP uses roughly 25% leverage.

PCI and PDI:

These are the two PIMCO funds in our portfolio. The funds are quite similar in terms of their assets and objectives. Both funds have a large exposure to mortgage debt. Due to a strong recovery in the housing market and steep fall in mortgage delinquencies, this asset class is likely to keep performing well into the future. We own both as they are equally strong performers.

KYN:

KYN is our fund for the MLP sector. The past few years have been tough for the sector, but it has been recovering nicely recently. KYN provides the exposure to some of the best companies in the MLP sector without the headache of K-1 (partnership) tax treatment.

NMZ:

NMZ is the diversified Municipal fund from Nuveen’s family. This fund is tax-exempt and should be used in a taxable account. If the portfolio was maintained in a tax-deferred account, we could replace NMZ by BlackRock Taxable Muni Fund (BBN), Guggenheim Taxable Muni Fund (GBAB), or Nuveen Build America Bond (NBB).

Performance:

The table below shows the funds in the portfolio in order of performance (from best to worst) as of July 6th, 2018. The performance has been calculated and sorted after including the dividends.

Also, here is the current portfolio as of 07/06/2018:

1

Sold during the period (Jan 2018 – June 30, 2018)

$0

2

New investments made during the period (Jan 2018 – June 30, 2018)

$14,953

3

Net new money invested (2 -1)

$14,953

4

Net Cash deployed so far (including dividends)

$216,508

5

Total Dividends collected

(from Oct 17, 2014, until 30 th June 2018):

$53,190

6

Net Cash position (07/06/2018)

$34,200

7

Cost basis (07/06/2018)

$200,000

8

Portfolio balance (as of 07/06/2018)

$265,204

9

Net profit/Loss (incl. dividends)

(07/06/2018)

$65,204

10

Return on original invested capital (65,204/200,000)

32.6%

11.

Net Gain/Loss for the Portfolio YTD (since January 1st, 2018 until 07/06/2018)

+2.65%

12.

Net Gain/Loss in S&P500 YTD (since January 1st, 2018 until 07/06/2018)

+3.34%

Dividends:

Total dividend earned from 1st January to 30th June 2018: $9,171

Total dividends earned until end of 2017: $44019

Total dividends earned since portfolio inception: $53,190 ($44019 + 9171)

(this includes $1,382 from securities already sold)

The current yield-on-cost (YOC) is 9.17%. However, the projected YOC is 9.66%. If you were to invest today in this portfolio, you would still get a very attractive yield of 7.94%. However, due to capital appreciation and a large cash reserve, the projected yield on the current value of this portfolio comes to 7.30%. The current cash reserve of $34,200 represents about 12.9% of the portfolio. Our target range for cash reserve is about 10%.

Security wise dividends:

Symbol

2018

Dividend since portfolio inception until 2017

Symbol

Jan - June 2018

Dividend since portfolio inception until 2017

CEFL

702.46

4392

PCI

887.16

4295.57

DNP

572.34

2853.38

PDI

717.72

4894.77

GOF

903.6

2945.43

PFF

356.93

2291.82

KYN

750.6

2694.51

RFI

578.76

3174.11

MAIN

436.1

1815.36

RNP

506.23

3006.29

NLY

392.1

1917.3

STK

564.26

2451.97

NMZ

431.53

2399.67

UTF

656.22

3062.65

HQH

490.19

252.35

ARCC

224.2

190

Total dividend since inception = $53,190 ($44,019 + 9171)

Performance Comparison With Benchmark:

Here are our two original goals:

1

Earn current income of 8% and preserve capital.

2

Provide roughly 2% or more capital appreciation over the long term.

As such, this portfolio is meeting or exceeding all of its primary goals when the un-deployed cash is excluded. For performance comparison, we have been using the traditional Stock/Bond portfolio as a benchmark. Thus far, the portfolio has done reasonably well against the Stock/Bond portfolio. In a nutshell, here is how we have fared so far against our goals:

  • We earned an income of $9,171 during the first six months (equivalent to $18,342 at an annual rate). The total dividends in 2017 were $17,148, so we should see an increase of 6.96%. The total of dividends/distributions, since inception, stands at $53,190.
  • The current yield on cost is at 9.17%. The projected forward yield on cost is higher at 9.66%. However, the projected yield on the current portfolio value (including the cash-reserve of about 13%) is lower at 7.30%. Please keep in mind this cash reserve provides the extra margin of safety and lowers the risk profile of the portfolio. Now, how much cash reserve to keep? We think we still need to bring it down to about 10%.
  • Capital preservation: Including dividends, the portfolio is up by 32.6% as of 07/06/2018. Morningstar portfolio calculates a 10.27% annualized return for this portfolio since inception if we were to exclude cash reserve.
  • Our benchmark for this portfolio is not S&P500, but a traditional stocks/bonds portfolio (40/20/40 Stocks/International Stocks/Bond allocation). We will assume that similar amounts were contributed on the same dates, and similar amounts were deployed. We will compare our Income-centric portfolio with a hypothetical stock/bond portfolio with 40/20/40 allocation to Vanguard Total Stock Market ETF (NYSEARCA: VTI), iShares MSCI EAFE - International (NYSEARCA: EFA), and (Vanguard Total Bond Market Etf (NYSEARCA: BND).

As of 07/06/2018

Total value

Dividends

8% Income portfolio

$265,227

$53,190

60:40 Stock/Bond portfolio

$244,205

$15,281

Closing Remarks:

As you can see, in spite of some challenges in 2108 and especially in the midst of a rising interest rate environment, the portfolio has been performing relatively well. The income has been consistently rising, even though some funds have cut distributions but some others have increased. Also, buying or adding money to some funds at the opportune time has helped a bit as well.

We still have a large cash reserve of roughly 13% of the portfolio, which keeps growing every month with new distributions. Even though a large cash reserve provides an extra layer of safety and lesser volatility, especially during rough times; however, it earns no yield, and it is slightly higher than we want. We aim to bring down our cash position to about 10%.

We would like to remind the readers that the CEF portfolio should not be considered a "core" portfolio. We do not recommend allocating more than 30-35% of the investment assets to this type of portfolio, though these decisions should be considered on a personal basis. Below is the allocation model that we like to follow:

Disclaimer: The information presented in this article is for informational purposes only and in no way should be construed as financial advice or recommendation to buy or sell any stock. Please always do further research and do your own due diligence before making any investments. Every effort has been made to present the data/information accurately; however, the author does not claim 100% accuracy. Any stock portfolio or strategy presented here is only for demonstration purposes.

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Disclosure: I am/we are long ABBV, ABT, ADM, ARCC, BUD, CL, CLX, CSCO, CVS, CVX, D, DEA, DEO, ENB, EVT, FFC, GIS, HCP, HQH, INTC, JNJ, JPC, JPS, JRI, KO, KYN, LOW, MAIN, MCD, MO, MON, MSFT, NBB, NLY, NMZ, NNN, NSRGY, NVO, NVS, O, OHI, PCI, PDI, PEP, PFE, PFF, PG, PM, RFI, RNP, STAG, T, TLT, UL, UTF, VLO, VOD, VTR, VZ, WBA, WMT, XOM. 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.