Switches Continue To Generate Alpha In Income Portfolios
Seeking Alpha Analyst Since 2014
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- Welcome to another weekday blog post from Systematic Income.
- We highlight our recent portfolio switch from OCCI to AAIC-C that has clocked in a 10% gain in less than three weeks.
- In a market environment of low yields, switches provide one way of generating decent returns.
- Take a 2-week no-obligation trial of Systematic Income and check out our Income Portfolios and Interactive Investor Tools.
Welcome to another weekday blog post from Systematic Income where we give an update on the recent rotation out of OCCI.
In a recent blog post we discussed a switch out of the OFS Credit Company (OCCI). As it happens, we rotated into the Arlington Asset Investment Corp 8.25% Series C (AAIC.PC) which was our highest conviction mREIT preferred, trading at that point at a yield north of 9%. So far the switch has gained 10% - 2/3 of it from the gain in AAIC.PC and the other third from avoiding the recent drop in OCCI due to the share offering.
Obviously, we didn't expect the share offering but with OCCI trading at a double-digit premium, holding it was not a very attractive risk/reward particularly given the very attractive valuation of AAIC.PC. In retrospect, we got out of OCCI a bit early as it continued to move higher but the reality is that no one is going to nail the timing exactly right on rotations.
Within the broader mREIT preferred sector AAIC looks very attractive with a combination of high agency exposure, low leverage and high equity/preferred coverage. The chart below captures three valuation metrics we view as most important - the allocation to agency securities, economic leverage and equity / preferred coverage. The stock has very low leverage (3.0x) for its level of agency percentage holding of 90% with equity / preferred coverage that is on the higher side across the sector. Our view remains that the stock is undervalued due to its failure to reinstate its common dividend which is actually a positive for the preferred though it likely puts some investors off as they interpret it as a sign of distress.
Apart from rotating into a more attractive valued security, the move from a CEF into a preferred highlights a key trend we have been discussing for some time which is that in the current market environment it makes sense to lighten up on CEF exposure in favor of individual preferreds.
We discussed this theme in a recent article on the service which hasn't been republished publicly yet but, in short, the discount volatility dynamic, low underlying yields and yield optics make CEFs marginally less attractive in the current environment. By yield optics we refer to the fact that CEFs look like they are delivering income levels significantly above those of senior securities, however, this isn't actually the case in many instances. More to come on this topic so watch this space!
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Analyst's Disclosure: I am/we are long AAIC.PC.
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