Shaking Up the Blended Income Portfolio

When we last wrote on January 6th we said that we would be primarily purchasing short and medium duration securities in the Blended Income Portfolio in 2017.  With this theme in mind we have added 700 shares of Medley LLC 6.875% Senior Notes (NYSE:MDLX) to the portfolio today. Medley LLC is the operating company of Medley Management (NYSE:MLY) and is an asset management company.  MDLX has been trading under par since it began trading last August.  We have made our purchase at $24.00/shares giving us a current yield of 7.13%.  The notes have a maturity date in 2026 which makes them a medium duration issue which fits perfectly with our current strategy.  Being a debt issue the distribution is an interest payment and not eligible for preferential tax treatment.

Additionally, today we purchased 800 shares of The Carlyle Group (NYSE:CG), a MLP (master limited partnership).  CG is an alternative asset manager with about $169 Billion in assets under management.  The company made a few missteps in the last couple of years and paid a fairly heavy price for their errors with their share price being driven down to $11/share from above $30 3 years ago.

Rather than regurgitating all of the logic behind this purchase we are simply going to refer to an article today on Seeking Alpha written by Alpha Gen Capital which outlines the situation quite well.  Currently the distribution by CG is 50 cents/share giving a healthy near 12% current yield.  Readers should be mindful that CG is a variable payment MLP, meaning they can move the distribution higher, or lower and there is no guarantee that the distribution will remain at this level.

On January 6th we also mentioned that we would be harvesting some profits from the portfolio and today we have done so.

We have sold the Prospect Capital 6.25% notes (NYSE:PBB).  We had purchased these when Prospect Capital and related issues took a “beat down” about a year ago.  We paid $19.50 and sold them today for $25.35.  This is not to imply there is anything wrong with these baby bonds, but the current yield had fallen to 6.15% and we suspect there is no prospect of further capital gains left thus the 6.15% is a bit meager for us.

Additionally we sold the CHS 7.50% cumulative preferred. (NASDAQ:CHSCL).  CHS (Cenex Harvest States) is a large agricultural cooperative and while we love CHS we think it is time to lock in some decent capital gains.  With the rise in interest rates we have already given back a good share of gains and there is no reason to continue to hold this issue with a current yield of 6.78% just to give back more gains later this year.

Lastly we have sold our Johnson and Johnson common shares (NYSE:JNJ). We have a very tidy capital gain in the shares and with a current yield of 2.61% we think we can do better.

In summary these moves should raise our income level by a few basis points overall (on invested positions) as well as give us a fighting change at a good potential future capital gain on The Carlyle Group.  We have further cash to get deployed in the next 10 days and will announce that as it happens.

Fixed Income Investors Drive Interest Rates Lower

Fixed income investors are thumbing their noses at the idea that interest rates are going to move higher because of the strength of the global and U.S. economy.  Today the 10 year treasury fell by 8 basis points to close around 2.36% after hitting 2.6% last month as the Fed moved the fed funds rate higher by 25 basis points.  Logically the move to 2.6% from 1.5% in early September was an overshoot.  Investors in preferred stocks and baby bonds had driven the average price of all issues down by 4-5%  last month but have now driven prices back up by 2-3% from the lows. Certainly there is a continued hunger for yield.

Investors have to form their own conclusions as to where they believe the economy and interest rates will go in 2017 as you can be almost certain that the Fed has no real idea of where they should go–their latest forecast is for 4 rate hikes this year–we think this is not likely.  Even if they do raise rates more than we believe the marketplace will determine the level of longer term rates–i.e. the 10 year and 30 year treasuries and unless the global economy explodes higher the Fed will be simply flattening the yield curve (short term rates go higher while long term rates remain flat or move higher at a slower rate than short rates).

Here is what we think will happen during 2017.  We believe there will be at least 1 interest rate hike, with a possibility of 2.  Each of these will be 1/4%.  Our thoughts on this are driven by a few factors.  1 of these factors is energy prices.  It appears to us that both crude and natural gas prices are now likely near the top end of the range for the year.  While today a 7.1 million barrel drop in inventories was announced there are around 4,000 DUCs (drilled but uncompleted) wells that can ramp up quite fast  and the drillers are becoming exceptionally talented in coaxing more oil or gas out of every well. The oil and gas producers are getting very efficient.

2ndly we need to watch inflation.  This dovetails with energy prices above as the one item that could shock prices quickly and severely  is energy prices.  We noted above that we would be surprised if energy prices moved much high–but anything can happen.  We believe that inflation can and will move a bit higher that the current rate, but remember the inflation rate in the last 12 months is a measly 1.7% (through the end of November)–this remains below the 2% Fed target.  Anecdotally we think wages will push inflation up somewhat as wages nationwide are moving a bit higher as minimum wage hikes take effect, but inflation rates should remain modest–2.5%.

Additionally, we have to focus on interest rates around the world since money flows are global–bond buyers will go anywhere in the world to find yield and you can be certain they are not getting safe yield anywhere on the globe that is close to that of U.S. notes and bonds.  Only Greece and Portugal have 10 year notes with yields higher than the U.S. and those are hardly low risk notes.  Germany now pays 24 basis points (a basis point is 1/100th of 1 percent), France 79 basis points and the UK is at 1.29%–hardly competitive with the U.S. 10 year treasury at 2.36% today. Japan has moved away from negative rates but still pays just 10 basis points on their 10 year–hardly competitive to a yield hunter.  Now there are occasional flickers of economic hope globally, but we need more than a flicker here or there to ignite interest rates.

We have always formulated our own “forecast” (even if it is wrong we formulate our forecast to guide our investing–last year expecting 3-4 interest rate hikes we focused on short duration securities and even though we were very wrong short duration performed ok–although likely a percent below high yield perpetuals) to help us determine if we want to invest in perpetual preferreds or long duration baby bonds or if we want to stay with shorter durations.

For 2017 we will primarily focus on short/moderate duration BUT will also buy a perpetual here and there. For instance we bought the NuStar Energy LP preferred units last month.  This is a 8.5% fixed to floating rate issue for which we paid $26.05 and is now trading at $26.76.  Fixed to floating rate issues trade with less volatility than fixed rate perpetuals.  When we do buy a perpetual it will be high yield (above 8% coupon) as these will trade firmer than investment grade.  This means it will likely be a mREIT preferred or two as these are the most dominant issues available excepting the shipping sector and the shippers are for the most part very high risk.

Beyond the above we will likely move out of the 2 CEFs we own as we are poor pickers in this arena so we just as well stick to what we do best.  We also will start harvesting some profits in the Blended Income Portfolio. We will be buying some healthcare REITs where there are some values in issues such as Omega Healthcare (NYSE:OHI) which caries a 7.49% current yield.

For those wanting to peruse the fixed to floating rate sectors we have these issues here. For those looking for short/medium duration issues you can find them here.

To get more information on preferred stocks and exchange traded debt (baby bonds), screen them, set up your own portfolio and receive email alerts, go to now.




2016, A Good Year

Investors have all kinds of goals for their portfolios, some realistic, some not, which is why we strive to define our goals based upon an investment style that suits our needs and temperment.  We have made 7% our goal for the last 3 years and generally have been successful–so why not leave it at 7% for 2017.  We know that when we stretch to try to garner gains much above this 7% level we stress out with worry and lay awake nights.  We don’t  “recommend” that investors ever buy a particular security as everyone has there own needs–so everyone is responsible for there own portfolio.  We simply try to lay out “options” through our model portfolios.

As we entered 2016 we knew it would be difficult to reach our goal because of the risk of higher interest rates.  Of course now we have the benefit of 20/20 hindsight and we know that there was only 1 rate increase (instead of a predicted 4) and we had sacrificed maybe 1-2% in returns being positioned in short/medium duration securities.  Oh well, since we had no great crystal ball we have to be happy with our performance–and we are.

Let’s look at the Blended Income Portfolio 1st.  The portfolio, which has a wide range of security types in it, is more heavily weighted in preferred, term preferreds and baby bonds.  These items compose 60% of the net asset value, while REITs are near 11%, while common stocks are just about 14% (counting the 2 Canadian issues we hold). The balance is spread among MLPs,  CEFs, ETFs and the dreaded “cash” (dreaded since it earns no return).  We originally composed this portfolio January 4, 2015 so it is now approaching its 2nd birthday.  In 2 years we have a gain of 13.19% which isn’t too bad against our 7% annual goal.  Because this portfolio was composed 1/4/2015 we missed a month of dividends and interest as we did not start collecting income until 2/2015.  Over this time frame the Standard and Poors 500 is up 8.73% (without dividends) so we are close to equal to the indexes gain.  The iShares Aggregate Bond (NYSE:AGG) is down 1.87% (not counting interest of around 2.50% annually).  The issue that performed the poorest in the portfolio was MLP NGL Energy (NYSE:NGL).  This was a poorly timed purchase for us as we bought shares at around $28/29 per share and it is now trading at $21/share–but since purchase it has traded as low as $7–yes $7.  If we truly believed in our purchase we should have purchased a truckload of shares when prices were low–but our MLP learning process is still a work in process.  We went through this process back in 2008 and 2009 when we were new to preferred stocks and while we purchased some shares back then at rock bottom prices ($25 issues as low as $5/share) we should have backed up the truck.  Like many of our readers we only began buying preferreds and baby bonds in the last 10 years and every year has been a learning process–we figure by the time we are 90 years old we will have learned (and probably forgotten) quite a bit — but the key lesson is that when “there is blood in the streets” there is truly opportunity.  Also we have held a small hedge all through the last year and it has cost the portfolio around 1/2% of performance.  This hedge is with Proshares Ultra Short Standard and Poors 500 (NYSE:SDS).  These ultra short instruments will lose value every month even if the index remains flat as they “roll” futures contracts so they are not good long term holds–we know this but held it just the same.  We have now set S&P500 2,250 as the “stop loss” for this hedge and will exit the position if hit.

We will make a few moves in this portfolio in the next week as we tweak for the year ahead.

Looking at the Short/Medium Duration Portfolio we find performance that really exceeded expectations.  Recall that this portfolio is composed of only short and medium duration securities.  The portfolio contains 4 term preferred issues and 14 baby bonds–and the key item of this portfolio is we DO NOT TRADE in this portfolio. During 2016 we had 2 issues called for redemption and we made 1 purchase.  The point of this is to garner a decent return without laying awake nights–all without “trading”.  Additionally shorter duration securities have less volatility that perpetual issues.  Honestly while there are people that seem to have some success trading, the VAST MAJORITY of people do poorly.  The vast majority of people do not have the time, or desire to trade–they only want a return that is respectable.  Through 26 months this portfolio has a gain of 14.35%–a return that is very near our 7% annual target.  We suggest investors study this portfolio and use it as a guideline for there own portfolio if a low stress 7% meets your needs.

Lastly the Moderate Duration Income Portfolio with Zip is really a variation on the Short/Medium Duration Portfolio.  This portfolio primarily contains medium duration securities, but additionally contains 1 or 2 REITs or MLPs which hopefully give the portfolio some “zip”.  Obviously when you hold only fixed income securities your upside is limited, but if you can add 1 or 2 issues that are believed to have some upside you can lift the total return by maybe a percent (of course if your “zip” issues fall you reduce portfolio returns).  This portfolio had more trades than the short/medium duration portfolio above.  The “zip” issue that we used in 2016 was apartment REIT Independence Realty Trust (NYSE:IRT).  We held these shares early in the year and sold to book a nice profit during the year and then repurchased when it came back down in price.  Obviously using a small portion of the portfolio in this manner creates a little more trading, but if we want a little “zip” we have to trade a bit.  This portfolio was created in August, 2015 and through this point in time has a gain of 11.42%.  Over the 16 months since inception this return was above our 7% annualized goal by a percent or so.  Interestingly the portfolio had a gain of about 10% the 1st year, but had some slippage as the anticipated rate hike took some wind out of the portfolios sail.  Just the same a 8% annual return is nothing to sneeze at and we would love to have a 8% return year in and year out.

For 2017 we again carry the portfolios forward as we are long term investors and it makes sense to continue to test strategies year after year.

We will be making some minor tweaks in portfolios in the weeks ahead as we get into the new year and will be letting you know what we are doing and why we are doing it.

Additionally next week we will outline what we believe the economy will be doing in 2017, because without a forecast (whether it be right or wrong) we won’t be able to formulate a plan for the types of securities we want to be holding during the year.


Added Saratoga Investment Notes to Portfolios

We have added the new Saratoga Investment Corp 6.75% notes (NYSE:SAB) to the Blended Income Portfolio and to the Moderate Duration Income with Zip Portfolio.

While we would prefer to have a bit higher coupon on our purchases these notes fit the requirments of some of our portfolios which demand we hold just short/medium duration securities and these notes have a maturity of 2023 so they fit our duration needs.

As we have done with our last 2 purchases we vacillated on the purchase and paid $25.88 for the shares–as we have mentioned before there is no excuse for this. We could have bought them down near $25, but instead did not make the purchase a priority in our lives and waited a couple of days after trading began before executing a trade.  Long term this is not of consequence, but why pay more than you have to pay?

Details of this issue are here.

Business Development Company Saratoga Investment Corp. Sells a New Baby Bond

Saratoga Investment (NYSE:SAR), a smaller sized BDC, with assets under management of just $272 million, has sold a new baby bond issue in a refinancing transaction.  The new bond has a coupon of 6.75% and a maturity date of 12/30/2023 making it a relatively short duration security.

The new issue from Saratoga is $65 million in size and the company has stated the intention to call their SAQ issue with the proceeds.  The SAQ issue has a coupon of 7.50% and became initially callable on 5/31/2016.  The issue being called was a $42 million issue so the new issue will readily cover the cost of bringing in the old issue, leaving the balance for general corporate purposes.

The new issue ticker symbol is SAB and there will be no OTC Grey Market trading since it is a debt issue and debt issues do not trade on the OTC prior to permanent market trading.

We note that we hold the 7.50% Saratoga baby bonds in all of the model portfolios and in addition we hold shares in our personal accounts.  The issue has provided a nice, non volatile, 7.50% income stream for quite a few years and we are sorry to see it go.  Now we will need to find a spot to redeploy the proceeds from call. It is very likely that we will go ahead and buy the new issue for our Short/Medium Duration Income Portfolio as well as the Moderate Duration Income with Zip Portfolio.  Even though the new issue has a coupon of just 6.75% with a maturity date of 2023 it fits the requirements of these 2 portfolios and swapping a new 6.75% for the old 7.50% is not significant damage to the income flow.

Details of this new issue can be found here.  We expect this issue to begin trading in the next couple of days.

To get more information on preferred stocks and exchange traded debt (baby bonds), screen them, set up your own portfolio and receive email alerts, go to now.



We Make Portfolio Changes

We have been very happy with the Short/Medium Duration Income Portfolio and the Short/Medium Duration with Zip Portfolio this year while we have been less than happy with the Blended Income Portfolio so we have started to make some portfolio moves to try to help the portfolio perform a bit better.

1st off we bought 500 shares of NuStar Energy LP 8.5% (NS-A) fixed-to-floating perpetual preferred stock. While this is a perpetual issue and we are mainly into shorter duration issues this issue pays are high coupon and then has a good floating provision with a base fixed rate of 6.766%.  Fixed to floating rate preferreds such as this will trade firm compared to regular perpetual preferreds so interest rate risk is modest with this issue. Of course we wish we would have made this decision earlier as we paid $26.05, which is a dollar higher than it traded around issuance, but the 8.43% current yield remains attractive and it is call protected until 2021.

Additionally we bought 500 shares of RAIT Financial  (NYSE:RFT) 7.625% baby bonds for $22.87/share giving us a current yield of 8.51%.  This issue has a medium duration of 2024 so it carries little interest rate risk.  RAIT is a REIT and was a controlling shareholder of multi family REIT Independence Realty Trust (NYSE:IRT) and their financials have been less than stellar in recent years.  On the other hand the company has announced significant steps to revive earnings recently and in fact just announced the completion of transactions which will contribute substantially to their efforts.  You can read some of the details here.  Needless to say if RAIT was an investment grade issue we would not be paid a current yield of 8.51% to hold their bonds.

These 2 moves additionally sopped up some of our excess cash that we have had on hand, but we continue with a cash position of 9.45% which is adequate for bargains if they come.  We are considering further moves in the next week and will post them when and if they happen.

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