The 8% Income Portfolio: High Income With Lower Volatility (And Market-Beating Returns)

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

2019 mid-year review of 8% Income Portfolio.

The portfolio has been meeting its goals both in the good times and the bad. Also, it continues to generate high levels of income, irrespective of the market environment.

We will provide updates on recent buys, dividends collected, and overall performance. As usual, we will compare the performance with a traditional 60:40 stock/bond portfolio.

The "8% Income Portfolio" continues to perform well during good times and bad. Currently, it provides 10.40% yield on the cost basis and 7.20% yield on the current portfolio value. During the first six months of 2019, the portfolio has returned 18.28% (21% after excluding cash) with nearly 40% less volatility than the S&P 500. Since inception (Oct. 2014), it has provided an annualized return of 10.20%, even after including a cash reserve of 10-15% at all times.

This is a high-income portfolio that in our view is suitable even for conservative investors, including retirees. We generally advocate a multi-bucket diversified portfolio. This "8% Income Portfolio" represents one of the buckets in our overall investment strategy, however an important one. This portfolio takes most of the risk while providing most of the income in our otherwise conservative strategy. Even though many folks would associate an all CEF portfolio as a risky portfolio, but our experience during the last nearly four and a half years has been quite different. We find that the consistent high distributions/income reduces the volatility and improves the overall returns that are comparable to the broader market if not better. In addition, we maintain a 10-15% cash position, which helps lower the volatility and also provides an opportunity to go bargain hunting at times.

If this income strategy is used as part of an overall multi-bucket strategy, we consider it appropriate for most retirees and near retirees as well as younger investors. As it's true in most 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. Please see our allocation model at the end of the article.

This income-centric portfolio was launched in October 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.

Comparable Performance to S&P500 with Less Volatility:

The chart below shows the performance of the 8% CEF Portfolio with S&P500 during the volatile period of Jan. 2018 to July 2019. The movement of the portfolio is similar to the S&P 500 but with much less volatility. The reasons are two fold. First, we have 10-15% cash in the portfolio that keeps the volatility down and provides an opportunity to buy at lower prices. Secondly, the constant flow of over 8% distributions into the portfolio lowers the volatility. For instance, we had a correction of nearly 20% during December 2018, but the CEF portfolio dipped only about 11% during that time. Then as the markets recovered, the portfolio recovered very strongly as well.

True to its name, this portfolio continues to generate high income, thus meeting its primary goal. Even though the total return of the portfolio is important to many folks, but it's a secondary goal to us since we know that the stock market never moves in a straight line. There will be ups and downs along the way, as shown by the above chart. In fact, we should take advantage of lower prices when there are substantial discounts available. From time to time, we put additional cash to work when the price of a security is low or the overall market is taking a beating. We provide real-time updates to the members of our HIDIY marketplace service.

Some Background:

Here's 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 stream 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 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 a few more funds and three individual company stocks to the portfolio from the BDC/ mREIT sectors. However, these three individual stocks form only about 10% of the portfolio size.

Portfolio Composition:

Here's the current portfolio consisting of 18 securities, three individual company stocks, and 15 funds:

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

17.

Morgan Stanley India Investment Fund (IIF)

IIF

Emerging Mkt Equity – India specific

18.

Calamos Convertible & High Income Fund (CHY)

CHY

Convertible and Debt Securities

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 an mREIT. ARCC was added in 2017. All three put together form only about 10% 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 reasonably well, providing positive returns on the invested capital when we include the dividends compared to a 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 roughly 2.5% 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 roughly $15 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 11.5%.

STK:

STK is an equity CEF and invests primarily in the technology sector. The fund currently yields 10.8%. Even though the fund deploys options strategy, however, most of the distributions come from capital gains. The fund is somewhat risky but also can provide high growth in good times. Due to the large appreciation since we invested, and some recent buys, the fund is just about 6% 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 the balance 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. KYN provides 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 (NYSE:BBN), Guggenheim Taxable Muni Fund (GBAB), or Nuveen Build America Bond (NBB).

IIF:

This is an emerging market, country-specific equity fund focused on India. The fund uses zero leverage and the fee is reasonable. Since this is country-specific, we will limit our allocation not to exceed 2.5% of the portfolio.

CHY:

The fund invests in convertible securities (45%), debt securities (40%) and preferred securities (6%). The fund is sponsored by Calamos Advisors. It provides monthly distributions and uses a leverage of about 33%.

Sector Allocation:

Position-wise Holdings:

Income Distribution Chart:

Sale/Purchases made since January 2019:

We made some opportunistic buys in the year 2019, reducing our cash reserve and increasing the income.

Symbol

Buy/Sell and

Date

Shares and

Price

Amount

CHI

Buy

04/16/2019

285

$10.50

$2,992.50

IIF

Buy

04/16/2019

141

$21.15

$2,982.15

NLY

Buy

06/14/2019

220

$9.08

$1,997.60

Dividends:

Total dividend earned in 2019 (Jan-June): $9,862

Total dividends earned until the end of 2018: $64,162

Total dividends earned since portfolio inception: $74,024 ($64,162+$9,862)

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

The projected dividend for the full year 2019 is $20,800. The current yield-on-cost (YOC) is 10.40%. If you were to invest today in this portfolio, you would still get an attractive yield of 7.20%. The current cash reserve of $32,560 represents about 11% of the portfolio.

Security-wise dividends:

Symbol

2019

Dividend since portfolio inception until 2018

Total Dividend As of Now

Symbol

Jan - June 2019

Dividend since portfolio inception until 2018

Total Dividend As of Now

ARCC

278.8

679.4

958.2

NLY

454.3

2745

3199.3

CEFL

597.3

5702.09

6299.39

NMZ

480.24

3304.58

3784.82

CHI

45.6

0

45.6

PCI

984.6

6385.33

7369.93

DNP

476.95

3998.06

4475.01

PDI

717.72

6601.45

7319.17

GOF

903.6

4752.63

5656.23

PFF

398.12

3227.71

3625.83

HQH

705.2

1429.52

2134.72

RFI

572.97

4331.63

4904.6

IIF

0

0

0

RNP

617.82

4111.74

4729.56

KYN

643.68

4249.71

4893.39

STK

814

4134.32

4948.32

MAIN

514.42

2762.32

3276.74

UTF

656.22

4364.51

5020.73

Total dividend since inception = $74,024 (64,162 + 9,862)

Performance:

The table below shows the funds in the portfolio in order of performance (from best to worst) as of June 30, 2019. The performance has been calculated and sorted after including the dividends.

Also, here is the current portfolio as of 06/30/2019:

1

Sold during the period (Jan 2019 – June 2019)

$0

2

New investments made during the period (Jan 2019 – June 2019)

$7,972

3

Net new money invested (2 -1)

$7,972

4

Net Cash deployed so far (including redeployed dividends) (231,600+7972)

$239,572

5

Total Dividends collected (from Oct 17, 2014, until June 30, 2019)

$74,024

6

Net Cash position (06/30/2019)

$32,560

7

Cost basis (06/30/2019)

$200,000

8

Portfolio balance (as of 06/30/2019)

$288,057

9

Net profit/Loss (incl. dividends)

(06/30/2019)

$88,057

10

Return on original invested capital (88,057/200,000)

44.02%

11.

Net Gain/Loss % for the Portfolio YTD including the dividends

(since December 31 st, 2019 until 06/30/2019)

12/31/2018: 243545, 06/30/2019: 288,057

+18.28%

11-A.

Net Gain/Loss % YTD (excluding the CASH Reserve)

+21.04%

12.

Net Gain/Loss in S&P500 YTD (since January 1st, 2019 until 06/30/2019)

+18.20%

Performance Comparison with Benchmark:

Here are our two original goals:

1

Earn a 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 its primary goal of earning 8% income. For performance comparison, we have been using the traditional Stock/Bond portfolio as a benchmark. Thus far, the portfolio has done very well against the Stock/Bond portfolio. In a nutshell, here's how we have fared so far against our goals:

We earned an income of $9,861 during the year 2019. The full-year dividend should be nearly $20,800. The total of dividends/distributions, since inception, stands at $74,024. The current yield on cost is at 10.40%. The projected yield on the current portfolio value (including the cash-reserve of 11%) is at 7.20%. This is a bit lower than our target of 8%, but it's also a function of the current value of the portfolio. It shows that our securities have appreciated quite a bit. Our goal would be to bring the current yield closer to 8% as we deploy more cash in the coming months.

Capital preservation: The portfolio value moves along with the markets, and currently, it's showing nice gains. But we have to look at it on the long-term basis. Including dividends, the portfolio is up by 44% as of 06/30/2019. Morningstar portfolio calculates a little over 10.43% annualized return for this portfolio since inception. It's even better at 11.4% if we were to exclude the 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 (VTI), iShares MSCI EAFE - International (EFA), and (Vanguard Total Bond Market ETF (BND).

As of 07/01/2019

8% Income portfolio

60:40 Stock/Bond portfolio

Cost Basis

$200,000

$200,000

Total Portfolio Value

$289,081

$259,273

Net Dividends Earned

$74,024

$21,178

Closing Remarks:

Even though the broader indexes have made new all-time highs recently, but the market has not done much in the last 18 months or so. We saw increasing interest rates last year. However, more recently, the rate environment has taken a 180-degree turn. Markets are now anticipating multiple rate cuts in the second half of 2019 and 2020. In spite of a volatile and uncertain environment in the last 18 months, the 8% portfolio has been holding on its own. Further, the total return performance of the portfolio has been comparable or slightly better than that of the broader market, with 30-40% less volatility. What's more important for this portfolio is to provide increasing levels of income, which has been consistently rising. 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 amount of cash reserve of roughly 11% 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. We will continue to look for opportunities in the market.

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. The author is not a financial advisor. 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. The stock portfolios presented here are model portfolios for demonstration purposes.

Disclosure: I am/we are long ABT, ABBV, JNJ, PFE, NVS, NVO, CL, CLX, GIS, UL, NSRGY, PG, KHC, ADM, MO, PM, BUD, KO, PEP, D, DEA, DEO, ENB, MCD, BAC, UPS, WMT, WBA, CVS, LOW, AAPL, IBM, CSCO, MSFT, INTC, T, VZ, VOD, CVX, XOM, VLO, ABB, ITW, MMM, LMT, LYB, HCP, HTA, O, OHI, VTR, NNN, STAG, WPC, MAIN, NLY, ARCC, DNP, GOF, PCI, PDI, PFF, RFI, RNP, STK, UTF, EVT, FFC, HQH, KYN, NMZ, NBB, IIF, CHI, JPS, TLT. 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.

Additional disclosure: 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. The author is not a financial advisor. 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. The stock portfolios presented here are model portfolios for demonstration purposes.