Bank On The Economic Recovery With 3 Big Yields

Summary

• The US government is making moves to super-charge this recovery.
• Many high-yield sectors, primed to benefit from the recovery, still trade at very attractive valuations.
• Investing in widespread floating-rate debt instruments can pay off in massive returns.
• Looking for more investing ideas like this one? Get them exclusively at High Dividend Opportunities. Get started today »

Bank On The Economic Recovery With 3 Big Yields

Co-produced with Treading Softly

How are you feeling lately? Do you think the economy is getting stronger and stronger? Or perhaps it is on the precipice of collapse now that President Biden has been sworn in? Maybe you feel that President Trump being out of office means the economy will finally be on the right course?

Source

You're not alone in your feelings. It can be important to know what consumers are thinking and feeling regarding the economy - so important that there are frequent attempts to determine how much confidence Americans have in the US economy.

Confidence in the US economy has been measured weekly by Gallup for a long time, you can see the results below:

Source: Gallup

As of Feb. 25, the confidence rating was -13. This is actually a 20 point improvement since November.

We can see that this confidence widely varies along partisan lines:

Source: Gallup

A sharp reversal of opinions was seen as the presidency of the United States switched from one party to another. So outside of measuring individuals' feelings about the economy, how is it actually doing?

When COVID-19 struck, it hit the US economy extremely hard. While it's up for debate as to whether the virus or measures to stop its spread were more damaging, that's a debate for another time.

We can see, however, that the US economy according to the US Weekly Economic Index shows how the US economy has been steady and strongly recovering since the drop in March and April. The US economy has room to run to recover to prior levels and beyond.

What will help to get it there?

• Continued low interest rates and an easy-money environment from the Federal Reserve.
• Large injections of liquidity by the government through spending bills, with more trillions to come.
• Infrastructure spending on the way.
• Recovering levels of employment.
• Pent-up consumer demand for entertainment and experiences.
• Consumers today with healthy balance sheets, more savings and less debt.
• In effect, the US and many global economies are swimming in liquidity, and it's liquidity that's the ultimate driver of economies.

I would like to add that the US economy is consumer driven, and consumers are in better shape than seen in decades. I expect the recovery of the US economy to be super charged, even before adding more government spending and stimulus. A V-shape recovery is on the way. As the government positions itself to be a major catalyst behind a rapid recovery, how can retirees and investors position themselves accordingly?

Betting on the US Economy Via CLOs

Often when three-letter acronyms get mentioned, investors get worried. CDOs were the building blocks that helped bring about the Financial Crisis due to financial institutions' recklessness. CDO stands for Collateralized Debt Obligations - they were a hodgepodge of various types of loans, bonds, and other debt instruments. Some CDOs even held tranches of other CDOs in them. Once they started to fall, a domino effect occurred.

MBS or mortgage-backed securities were also prevalent for being filled with poorly originated loans and given strong ratings by corrupted rating agencies mostly looking to make a buck. MBS still play a massively important role today within the financial systems of the United States, but regulations regarding them have become stricter and stronger - which is better for all of us.

Among this party was one more major member, CLOs or Collateralized Loan Obligations. CLOs are made up of Senior Secured Loans or SSLs, which are secured by the entire assets of a company. They are originated by banks as well as business development companies, like Saratoga (SAR) with 7.3% or even Owl Rock Capital (ORCC) yield 8.8%. These CLOs are essentially mini banks. They bundle the loans together and use money from investors to fund them or buy them. The investors get interest payments from the CLO's loans. The key here is that some investors are willing to accept less interest to get priority in payments, while others are willing to accept more risk for the potential of higher payments.

CLOs performed very strongly through the Great Financial Crisis - actually outperforming the S&P 500 during that time.

Why are we talking about that collapse in the market and subsequent recovery? Because we're in the midst of recovery now.

Exposure to The Entire US Economy and Its Rebound

CLOs provide exposure to a swath of the US economy in a higher risk/reward format. CLOs are not comprised of small unknown firms but middle-market to larger firms. Dell (DELL), Lumen Technologies (LUMN), and Bass Pro Shops are all examples of well-known or publicly traded companies who have SSLs within CLOs currently. CLO funds readily available on the market buy CLO equity tranches - the higher risk position with the largest payout. During the drop in March 2020, CLO equity tranches were devalued (trading at wide discounts to PAR value) while not suffering any real-world harm. Default rates, the amount of CLOs going bust, remained exceptionally low vs. the widespread fear-mongering in the market. We're now well past that timeframe, as such the optimism in the market and steady recovery of the US economy makes buying CLO funds now a more rewarding proposition.

Our 3 High-Yield Top Picks

Well known CLO funds, or CEFs that hold CLOs have followed the US Economic Index we observed above:

1. XAI Octagon Floating Rate & Alternative Income Term Trust (XFLT) yielding 10.2%,
2. Highland Income Fund (HFRO) yielding 8.7%,
3. Oxford Lane Capital (OXLC) yielding 12.3%,

All of these are serving as our examples in the chart above. Why do we like each of them? Let's talk about it.

XFLT has run ahead of the group due to its 50%-50% exposure to CLOs and SSLs. Allowing them to enjoy the swifter recovery of SSLs, while now positioning themselves to benefit from the recovery in the CLO space.

HFRO is an interest fund with a diverse span of investments. Currently, its exposure to CLO is only 17% of the fund. As such its fall was less extreme than our other two examples but its recovery has been timid as well. CLOs are helping boost the fund's income.

HFRO is currently trading at an extreme discount to NAV. This means its market pricing has room to readily improve while its underlying assets have the ability to benefit from the strengthening US economy via CLO exposure.

OXLC has long been a well-known CLO fund. They were able to leverage 2020 to allow them to buy more assets at record low prices. OXLC had just finished offering a preferred security prior to the drop in CLO values - great timing indeed. Lately each monthly and quarterly NAV update has been something to cheer as NAV rises sharply again and again. OXLC's rising NAV and as such rising share price isn't out of gas yet.

Bottom Line

CLO funds have seen strongly recovering NAVs and rising earnings in relation to their recovering NAVs. As such we see further gains on the horizon for investors who take advantage of the relationship between CLOs and the expected performance of the US economy. It's an easy way to monetize the recovery into strong income during a period of time where rates are low. A small dose of CLO funds can provide an outsized boost of income for any dividend investor's portfolio. Use that added income to enjoy monthly, or even reinvest into other opportunities. The choice is yours once those checks start rolling in!

These three funds provide high immediate income for your portfolio. They all pay large monthly dividends and have exposure to CLOs via different routes.

1. Wanting to be more conservative? Buy XFLT with its exposure to CLO equity and debt tranches.
2. Want to have buy an extremely discounted fund with a wider exposure? HFRO is great for just that purpose.
3. Want to go all in on the bet that the US economy is going to continue to recover strongly? OXLC is the way to play.

Now you can take these distributions to the bank to stash away, reinvest in more opportunities, or pay your bills while enjoying the economic recovery.

Don't believe in the US economy? The opposite bet is yours to play. I'm very confident that the US economy will rebound, and the best is yet to come! I also often believe fighting the Federal Reserve is a losing bet.

Analyst’s Disclosure: I am/we are long HFRO, XFLT, OXLC, SAR, AND ORCC. 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.

Treading Softly, Beyond Saving, PendragonY, and Preferred Stock Trader all are supporting contributors for High Dividend Opportunities. Any recommendation posted in this article is not indefinite. We closely monitor all of our positions. We issue Buy and Sell alerts on our recommendations, which are exclusive to our members.