Absurd, Outrageous, And Fully Covered: 8%-Plus Yields Are Available

Summary

• How much income does your portfolio generate? You can sprinkle in these picks and make it even higher.
• I'll take my retirement with a main course of income and a side salad of Benjamin Franklins please.
• Aim small, miss small.
• Looking for a portfolio of ideas like this one? Members of High Dividend Opportunities get exclusive access to our model portfolio. Learn More »

VioletaStoimenova/E+ via Getty Images

Co-produced with Treading Softly

Recently, I was reminded of a motto heard in the film "The Patriot." In it, a former war hero and now farmer played by Mel Gibson ambushes a group of British soldiers in the wood with two of his sons. He reminds them of a principle of aiming when he reminds them to:

Aim small, miss small

What does that mean? When it comes to accuracy, it's better to aim at the smallest part of your target, that way if you miss it, you still hit the target in general. So you aim at the bullseye on a target, this way if you miss, you still hit the target.

When it comes to income investing, I suggest you aim high, miss high. That means you set your goal for income well above the annual income you need, that way if you miss your goal, you'll still be well in the realm of a livable income from your portfolio.

Today, I want to help you ambush two excellent high yields. They'll help your portfolio produce excellent income - even in small amounts. I like to think of them as income catalysts.

Let's dive in.

Pick #1: PDO - Yield 8.3%

Many of the finest things in life are exceedingly rare. Rare things are usually very expensive. People will pay massive premiums for a rare bottle of wine, an ancient bottle of scotch, a unique gemstone, or a limited edition painting which are sought after by those with a lot of money to spend.

I like rare things too, but you won't find what I'm looking for at a Sotheby’s Auction House, nor will you find me paying a lot for the rarities I seek out. One of my favorite rarities to buy is a PIMCO fund trading at a discount to NAV.

PIMCO Dynamic Income Opportunities Fund (PDO) is one of the newest members of the PIMCO family funds. PDO is now trading at a 5.4% discount to NAV. Likely, its youth is part of the reason. PDO in allocations is most comparable to PIMCO Corporate & Income Opportunity Fund (PTY), PIMCO's best performing fund of all time. PTY has been operating for 20 years, and since inception, you can count on one hand the number of times it traded at a discount to NAV: Shortly after inception, during the Great Financial Crisis, in late 2015, and very briefly in March 2020.

Data by YCharts

Despite PTY being a bond fund that has outperformed the S&P 500 since its inception nearly 20 years ago, there are still plenty of doubters.

"But the leverage!!!" is the most common rallying cry of the bears. They claim that it's super risky, yet PIMCO has operated with materially the same strategy for going on 20 years. Through the Great Financial Crisis, through COVID, the leverage that PIMCO employs on a routine basis did not have a crippling impact. Why?

As a percentage of assets, the leverage is high, often over 40%. Though, CEFs are legally restricted to borrowing only 33% of NAV. The key is that PIMCO primarily utilizes "repurchase agreements." These are non-recourse obligations where the securities PIMCO is buying are the collateral for the "loan," this is a very common method to finance bonds and mortgages.

The key is that in the event of default, the lenders' only recourse is to take the collateral. This is what keeps PIMCO from triggering the 33% debt limitation, because PIMCO's equity at risk from the debt is quite low. Here is a screenshot from PDO's semi-annual report:

PDO's semi-annual report

There are two key highlighted numbers here. PDO owes $1.6 billion. This obligation is secured by collateral with a market value of $1.9 billion. Then, in the worst-case, end of the world scenario, PDO surrenders the collateral. Losing $1.9 billion in assets, and erasing $1.6 billion in debt for a net loss of $300 million. A total impact of $2.72/share is caused by the leverage which is approximately 15% of NAV. Consequently, the fund is no riskier than any other bond fund with modest 15% leverage.

"What about rising rates?" is the next thing the bears will say. Well, what about them? Here's PTY and PDI (PDI) the last time the Fed started a raising cycle. See that line on the bottom with the lowest total return? That's the S&P 500.

Data by YCharts

Turns out that selling PIMCO funds to invest in equities because rates were rising wasn't a very smart move.

Even seven years later, the market still hasn't learned. It sells off the PIMCO funds because rates are rising and that is supposed to be "bad." It created a fantastic buying opportunity back then, and it has created a fantastic buying opportunity again today.

I love several of the PIMCO funds, and it's often difficult to choose between them. Yet today, PDO is trading at a discount to NAV, it's headed by the same managers and has a very similar style as PTY yet trades at a hefty discount. Learn from history. When quality PIMCO funds are trading at a discount to NAV, buy them.

Pick #2: OXLC - Yield 12.6%

Oxford Lane Capital (OXLC) is a CEF that invests in CLOs (collateralized loan obligations). At HDO, we have been extremely bullish on CLOs coming into 2022.

CLOs are bundles of leveraged loans. These are loans, usually originated by banks to companies with B/B+ credit ratings. They are "senior secured" first-lien loans. These loans are at the absolute top of the capital stack. They're senior to any other debt or equity the borrower has.

The CLO bundles these loans together and then sells "tranches" based on repayment seniority. With each payment the A-tranches have to be paid in full first, then the B-tranches and so on. OXLC focuses primarily on the "equity" tranche, this is the tranche that gets whatever is left.

Since the equity can't collect a penny until the payments have been made to all the "debt" tranches, it is in a "first loss" position. If a borrower defaults, it's the equity tranche that gets paid less.

So when we're watching CLO equity positions, our primary concern needs to be default levels. How many borrowers will be unable to pay? How many borrowers must be making their payments to have a good return?

Keep in mind that OXLC is getting credit card type yields. As they reported in their Q4 Investor Presentation, OXLC's cash yield on its investments is 29%.

Q4 Investor Presentation

In other words, if all of the borrowers paid as agreed, OXLC would be yielding 29%! Like a credit card company, you should assume that defaults will happen. OXLC collected a yield of 29% last quarter, but some of that will likely be offset by future losses if borrowers default. The "weighted average effective yield" is a measure that reflects the historical average default rates of a little under 3%, which is the effective yield that OXLC can expect to receive if default rates are average over the long haul.

Right now, the default rate among leveraged loans is minimal. There hasn't been a single default in 2022 and only three defaults in the past 12 months.

TCW

Default rates are at all-time lows, and just getting back to historical averages would require a dramatic increase. This means that the odds are high OXLC is going to earn substantially more than the "effective" yield indicates unless we see a significant spike in default rates.

Yet, despite cash flow being incredibly high, in February, equity tranche values declined to $59.60. In other words, there's $100 in face value owed by the underlying borrowers and OXLC is paying under $60. These are incredibly low prices in the backdrop of default rates being near 0%.

Over the past year, OXLC has increased its CLO holdings by over 38%, it has recognized the incredible buying opportunity and backed up the truck. It had been retaining excess cash flow for reinvestment and selling shares at a premium to NAV to now buy up CLO equity positions as fast as it can.

Last quarter, OXLC produced GAAP earnings of $0.29. GAAP uses the more conservative "effective yield" described above. This covers OXLCs newly raised dividend by 128%. OXLC's core earnings were much higher at $0.44, covering its dividend by 195%!

OXLC has great coverage, even though a very large portion of its portfolio is not yet producing any cash flow. As of December, $382 million of investments, approximately 30% of OXLC's portfolio, had not yet made its first distribution. That cash flow will start coming in the next two quarters.

Q4 Investor Presentation

OXLC is yielding over 12.5% today, it's covering its dividend by 128% by GAAP net income, and 195% by cash earnings, and its cash flow will be growing at a double-digit pace in the first half of the year. OXLC is an incredible opportunity to get such a high yield that is well-covered and has very high potential for more dividend growth.

This is why the CLO sector is one of our favorite opportunities of 2022.

Dreamstime

Conclusion

These two absurd and outstanding yields are available for you in the market today. It's not often I can present to you a 12% yield or higher yield that has an extremely high level of coverage - OXLC is a real gem that if you don't have you're missing. Don't let OXLC be your carbuncle and snap up this opportunity.

With PDO, its coverage was so strong that we got a great Christmas bonus via a special dividend. I expect PDO to continue to give me excellent income month after month. Many of my readers ask for great monthly picks, today, I give you two.

Monthly dividends are extremely nice as most of our bills and expenses recure on a monthly basis. Each cash dividend is an infuse of opportunities and flexibility into your bank account. I love having the flexibility in my life and portfolio. You can have it too.

Aim big, miss big, still end with an outstanding retirement. Welcome to income investing.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of PDO, OXLC, PDI, PTY either through stock ownership, options, or other derivatives. 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, Preferred Stock Trader, Philip Mause, and Hidden Opportunities 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.

Comments

[houtex]

Well those two didn’t work out over the ensuing 12 months.

[Scoe]

PTY and OXLC have pretty terrible risk adjusted returns. Both got annihilated in the pandemic. I have no idea what you like about this stuff.

[houtex]

@Scoe

For fun, I looked at the historical volatility of OXLC and checked to see how much leverage you would have to apply to VTI to achieve the same level of returns volatility. It’s 100%. So if you invested $10,000 in OXLC you are taking on the same level of returns volatility as buying $20,000 of VTI and borrowing $10,000! (And of course if you want to withdraw $1,000 a year, you can do that too, and you’d have about 6x more money by leveraging up VTI. Again, with the same amount of risk). All data calculated from OXLC’s inception.

[PendragonY]

@Scoe

Thanks for sharing and explaining that you didn't understand the article we wrote on why PTY and OXLC are good investments. We will have to do a better job of explaining ourselves in the future.

I am long both PTY and OXLC and both have done well for me. Part of that performance was driven by buying more shares when the price was low due to the COVID crash.

[sky4it2012]

you know Rida I pledge to myself never to let you talk me into too risky of investments, I dont want CDO's but those Pimco funds are enticing.

Rida your a risky nut, but love your articles

[PendragonY]

@sky4it2012

We don't recommend any CDOs. CLOs are a very different investment.

[sky4it2012]

@PendragonY

I admit I dont understand the difference or how they work in general.

[PendragonY]

@sky4it2012

One of the main differences is that CDOs allow all kinds of debt into their pools, even tranches from other CDOs. CLOs are limited to secured first lien corporate loans.

[CAVU Mark]

I always look forward to Rida's alluring article titles.

[sky4it2012]

@CAVU Mark

me too

[Elk Tart]

Making money off of loans is risky business, as we head into a recession. Many CEFs are overlevered. There's a reason those yields are so high.

[ButscherDoug]

@Elk Tart As long as the dividend rate is covered, I could care less what the dividend yield is.

[PendragonY]

@Elk Tart

PIMCO has quite a lot of experience making money off of loans and doing so in good times and in bad.

CLOs did quite well for those investors who didn't panic at the start of the GFC, so I think they will be fine this time too.

[PendragonY]

@ButscherDoug

I want an attractive yield as well. But yes, covering the distribution is very important.

[mysonchino]

For all the doubters, shell game theory crowd etc. the total return on NAV for OXLC the past 3,5&10 years has been 14%+, 11%+ & 10%+. The market performance has been 8%+, 9%+ & 11%+. As long as NAV return is respectable the dividend is secure. It's the cash dividends that buy meat, potatoes and beer not the capital appreciation.

[Ptstanford]

@mysonchino Yes, if I'm not mistaken... the total return on NAV is a sure way to tell that the distribution is covered by income to the fund, and not a destructive Return of Capital.

So as a simple example if the Total Return on NAV for 3 years was 10% and the distribution was 10%... then the CEF is in good shape.

[Steven Bavaria]

@Ptstanford
Exactly! seekingalpha.com/...

[sky4it2012]

@mysonchino

dont talk like that I will have to buy

[JJG]

I bought this after the crash of 2020 for $2.32 and have been reaping the dividend since then. Even with a reinvest I'm up 232%. A great buy I would say.

[PendragonY]

@JJG

I didn't get quite that low of a price but did pick up some at during that period.

[Bobbie B]

Rida just looks at yield, not capital appreciation or depreciation.

[PendragonY]

@Bobbie B

That isn't true. Yes, the distribution is our primary goal. But that isn't the only thing we look at.

[SleepyInSeattle]

@Bobbie B Unfortunately! An excellent way to erode capital and lose money.

[GreenguyMN]

After reading this article, I looked at a couple of my O’s, OXLC and O. I entered each position around the same time (about 2-1/2 years ago). OXLC share price is down 24% while paying me 10-12% annual dividend, so I am about even, or up slightly. On the other hand, O’s share price is up 24% while paying me 4-5% in annual dividends. Comparable risks?, probably not. I intend to continue to hold OXLC with the expectation that better days are ahead. However, right now they are not my favorite O.

[Rida Morwa]

@GreenguyMN I like O as well, its yield is below my target range but we also made moves around it in 2020 when the yield was elevated.

[PendragonY]

@GreenguyMN

I own both O and OXLC. The risks aren't at all the same, and I didn't buy either in the hopes of selling it later for more money. I bought both for the cash flow.

[Scoe]

@GreenguyMN Both O and OXLC have high vol, poor risk adj returns, and massive drawdowns. Can't decide which is worse.

[MegaDivGuy]

Color me confused.

Rida, wasn't OXLC your "pick of 2022"?

I dumpted it a couple of months ago at a significantly higher value than today's. This moment, it's at $7.11. If you don't mind my asking, what gives?

[Rida Morwa]

@MegaDivGuy OXLC is still one yes, we see it performing strongly in 2022, however it is prone to bouts of irrational movements so it offers more entry points.

[Jetta2000]

@Rida Morwa I love this phrase:

".....however it is prone to bouts of irrational movements so it offers more entry points." LOL

[nickencio]

@Jetta2000 in other words in goes on sale often. You can buy it on Rodeo drive or at a Compton yard sale

[fairmountcreek]

TFSL & NYCB.
DRIP them.
Mortgage rates now over 5%,
both banks yielding over 6%.
Interest rates will rise this year.
No games.

[Tradar7]

PDO's started one year ago with a $20 NAV. It has dropped to about $18. That loss exceeds its dividend paid and in light of announced interest rate rises it seems that a discount is probably warranted (despite how tempting it may look in comparison to the other PIMCO funds). Just saying . . .

[Rida Morwa]

@Tradar7 PDO trades around bonds which have moved into the discount to PAR territory, so when they mature, PDO will get more than their current trading value. Its good to understand what a CEF holds to understand NAV movements.

[Tradar7]

@Rida Morwa Unless they paid more than par for some of them in which case those will mature to a lesser face value. Also, they may need to sell some to cover operating expenses which may cut short a recovery to par on those that fell below.

[JRock60]

Time plot shows OXLC started at $20 then shortly sank to $15 for 5 yrs, then sank to $10 for 5 yrs and now rising from $5 to current $7! High yield but is it a shell game??? How much does one really gain??? Have to see year by year analysis starting at different dates 5 years apart. Also results if held in ROTH, IRA and non-IRA accounts? How dependent on your tax bracket? What tax surprises could come up?

[LostinShalimar]

Why is the immediate assumption that the sell-off is due to rising interest rates rather than the forecast for a recession? Wouldn't it be safe to say that a recession would likely impact cash flows more than rates? Or do you see them working as an inseparable pair?

[Howard CostaRica]

@LostinShalimar the mechanism the Fed employs is raising rates to tamp down inflation by inducing a recession, which by its nature with deminish aggregate demand thereby reducing inflation.

To me they are inseparable.

[DutchGuy2]

How about Höegh LNG Partners LP (HMLP-PA) 8,75% Cum Pref. at only USD 23,60?

9,3 % effective yield in todays most favorite market; LNG transport Carriers

[racerkeith]

@DutchGuy2 No K-1, and currently at a 5.6% discount to Call Value?
I'm in!

[Littlebeef2]

@racerkeith careful. Parent has offered to purchase. I haven’t heard an update. Might be ok for Preferred but idk. Lack of transparency is an issue. I have both common and pfd. Thankfully not much

[racerkeith]

@Littlebeef2 Thanks. I'm focused on preferred shares.

[Steven Bavaria]

Rida -
Good article. OXLC is one of my major personal holdings and is in one of our Inside the Income Factory® model portfolios.

[Rida Morwa]

@Steven Bavaria Thank you for your kindness, always nice to see you when you swing by!

[houtex]

Just for fun, VTI has historically had twice the risk adjusted returns as OXLC and would give you ~50% more value even after withdrawing 11% (to mirror the yield on OXLC) since OXLC’s inception . Remember that if you are looking for something safe: a broad market stock fund has historically returned more, with less risk (lower draw down, lower stdev, etc.). Things may be different in the future, of course. https://tinyurl.com/y7hupnax

[houtex]

You say CEFs can borrow 33% of NAV. If you’re thinking of the regulations in the 40 act that is not true. The limit is debt over total assets, not net. Very different.

[vvvviking]

The CLO market is going to be a disaster. CLOs are almost entirely floating rate debt.

[Rida Morwa]

@vvvviking How will that be a disaster?

[PendragonY]

@vvvviking

Why do you think floating rate debt is a problem in an environment of RISING interest rates?

[vvvviking]

@PendragonY Is that a rhetorical question? You realize you are taking credit risk here. Credit risk leveraged through a) a CLO structure, and then b) through a corporate structure.

What happens to the debt coverage ratios of these small and mid market companies when interest rates rise?

Also, the OXLC's of the world are not getting paid floating rate, they are getting the residual after all the senior bonds in a CLO are paid. The senior bonds in a CLO are floating rate also. So the equity does not necessarily benefit from rising rates. But the borrower has to pay it.

Have you ever read a pre-sale report for a CLO? You really should before promoting these companies. They are free on any rating agency website.

[DrPickles6000]

In all fairness OXLC was your pick of the year for the paid crowd. The yield is 12% but it has lost 12% YTD.

[Rida Morwa]

@DrPickles6000 Using SA's data, OXLCs YTD total return is 7.1%

[DrPickles6000]

@Rida Morwa it was 8.07 to start the year. It is decidedly not up YTD (that means year to date)

[sme20]

@Rida Morwa You should let SA know their data is wrong. OXLC--12/31/21 close $7.71. 4/5/22 close $7.14, a net loss of .57. Total distributions for 2022 equal .225. Net total return equals a negative .345 or a negative total return of 4.47% YTD.