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This 9.5% Yielding CEF Is The Gift That Keeps On Giving

“Taper tantrums” in the credit markets are giving investors another ideal buying opportunity with junk bonds. The “smart money” remains bullish on junk bonds for 2015. Junk bond ETF’s make sense, but bargains and higher yields are possible with closed end funds that trade at a discount. My favorite closed end fund trades for a 7% discount to net asset value, it yields 9.5%, and it pays shareholders every month. Here we go again, the markets are having another “taper tantrum” and that has caused some selling pressure in junk bonds. We have seen pullbacks in the junk bond sector many times in the past few years and each one has been a great buying opportunity. This recent sell-off appears to be another golden opportunity to buy high-yielding assets from investors who are either uninformed or just plain overly focused with short-term thinking. Let’s take a look at the chart of a popular junk bond ETF below: (click to enlarge) As the chart above shows, the SPDR Barclays High Yield Bond ETF (NYSEARCA: JNK ) is now trading near the 200-day moving average of $38.59, which is a potentially strong support level. At this level, the potential downside risk could be limited and that makes this an even more attractive buying opportunity. Furthermore, there are other good reasons to be buying junk bonds now: The market has been so overly focused on this potential rate hike that it seems like many investors are acting very irrational over the fear of any rate hike. However, a closer look reveals that there is really nothing to fear, because like just about everything in this economic “recovery”, any rate hike is likely to be very minimal. One analyst in a recent Washington Post article describes the potential rate hike as being “bupkis” or “absolutely nothing” in terms of the size. The article states: “I don’t expect that they’ll do more than a quarter point,” said Ed Yardeni, president and chief investment strategist of his own advisory firm Yardeni Research. ” Bupkis as we say in New York,” he added, using a Yiddish word that has come to mean ‘absolutely nothing’ in English. “I think they’ll do the bare minimum,” he added, “for credibility sake. To show they can. They haven’t had any practice.” He predicted that the Fed’s action will be described as “one and done.” The reality is that the stock market and high yield bonds could rally as soon as the “rate hike” takes place as the certainty of this event could calm irrational investor fears and allow the market participants to realize that even after a quarter point hike, stocks and high yield bonds are still the only game in town. All this hand-wringing over a quarter point hike is irrational because it is nowhere near enough to make savings accounts, money market accounts or CD’s, a competitive asset class when compared to dividend stocks or high yield bonds. It appears that the “smart money” sees this and that is why firms like Goldman Sachs (NYSE: GS ) are bullish on junk bonds for 2015 . Another long-term positive factor is that the European Central Bank’s new bond buying program is creating more demand for high yield assets. A recent Bloomberg article , states that the European Central Bank’s bond buying program (quantitative easing) is pushing yields below zero on nearly $1.7 trillion worth of debt and that is also creating more demand for high yield assets. Furthermore, the fact that interest rates can move up a little (ok, barely) is a bullish sign for the overall economy. A stronger economy means that junk bond default rates could decrease and credit ratings could increase thereby making the bonds more valuable and lower risk. I believe it makes sense for investors to accumulate shares in JNK but there is another way to get an even higher yield and a bargain…… and that is to consider closed end funds, or CEF’s, which can trade for a discount to net asset value. In this sector, my favorite closed end fund is the Pioneer Diversified High Income Trust (NYSEMKT: HNW ). This is a CEF which primarily invests in high yielding bonds. For numerous reasons, this remains one of my favorite ways to invest in junk bonds: It is well diversified, it trades at a discount to net asset value, it pays a dividend every month, the payout appears secure, plus it yields 9.5%. The Pioneer Diversified High Income Trust has around 432 holdings which indicates it is well diversified. This fund has an average duration of just 3.02 years, which means that duration risk is very low and that is another reason why this fund is very attractive. The Pioneer Diversified High Income Trust has average earnings per share of more than 16 cents per month . This means the monthly payout of 13.5 cents per months appears very solid. (click to enlarge) The chart above shows that the share price is now a bargain at just about $17, because the net asset value (as of June 11, 2015) is $18.32. The current share price represents a discount of about 7% below net asset value. That is a large discount and it is one that has not historically lasted for long as rebounds have typically quickly followed these types of pullbacks. I believe that the market is overly focused on a “bupkis” rate increase and that means investors will once again be looking to buy high yield assets. A quarter point increase is not enough to make the generous 9.5% yield that the Pioneer Diversified High Income Trust any less attractive to most investors who desire income. The 7% discount to net asset value makes it a real bargain. Plus, with the generous yield, and with the dividend payout being made to investors every month, this closed end fund is like a gift that keeps on giving. Here are some key points for the Pioneer Diversified High Income Trust: Current share price: $17.10 The 52 week range is $16.43 to $21.63 Annual dividend: $1.62 per share (or 13.5 cents per month), which yields about 9.5% Here are some key points for SPDR Barclays Capital High Yield Bond: Current share price: $38.69 The 52 week range is $37.26 to $41.82 Annual dividend: about $2.40 or (20 cents monthly) per share which yields 6% Data is sourced from Yahoo Finance. No guarantees or representations are made. Hawkinvest is not a registered investment advisor and does not provide specific investment advice. The information is for informational purposes only. You should always consult a financial advisor. Disclosure: The author is long JNK, HNW. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

VNQI: International Equity REITs Yielding 3.85%

Summary VNQI is a far better method for international equity than buying ADRs. The Vanguard Global ex-U.S. Real Estate ETF has everything most investors would want. Intense diversification combined with strong yields. Investors need to consider the bid-ask spread when buying into an ETF, even if they are holding it for the long term. Investors need international exposure and in my opinion the best way to get that exposure is through diversified ETFs with very low expense ratios. One of the ETFs that I am personally using for my international exposure is the Vanguard Global ex-U.S. Real Estate ETF (NASDAQ: VNQI ) and I can tell you from personal experience I like the investment much better than equity investments where the ADRs (American Depositary Receipts) are charging me fees for holding the equity. Previously, those fees could only be deducted from dividends so I made the unwise move of making an equity investment through ADRs that had no dividend. If you want to know more about ADRs, read this article from Charles Schwab . The ADR is awful After the changes to allow agents to collect fees even if the underlying security did not pay a dividend, I found I had the single worst type of “investment”. This is the kind of “investment” that pulls money out of your pocket instead of putting money in. It’s like a negative dividend, and I’m less than thrilled about it. I’ve held onto that stock so I could time the sale for a tax loss and it looks like this year will be the year to do it. Due to how large the tax loss will be, I will be reaping it for years to come. I could sell smaller positions each year rather than carrying the loss across multiple years, but I’m not fond of holding any security with a negative dividend. Vanguard Global ex-U.S. Real Estate ETF is excellent Instead of providing negative cash flows, the Vanguard Global ex-U.S. Real Estate ETF is offering investors a distribution yield of 3.85%. I like the yield, I like the business model of equity REITs, and I like Vanguard as the manager of the fund for a couple reasons. Reason 1: Opaque When an ETF is going to be investing in securities that are even remotely illiquid, I would like to see some opaqueness. Vanguard does not regularly update the holdings of their ETFs and makes it more difficult for investors to know precisely what is inside the ETF. By making it more difficult for institutional investors to know what stocks will be bought and sold by the ETF, Vanguard is able to discourage front-running of their trades. If someone was able to effectively front-run the Vanguard trades, they would make some serious profits and the returns to holders of the Vanguard ETF would be marginally reduced. Even if the reduction is marginal, I don’t want any reduction in my returns. It is extremely rare that I will endorse a strategy that is more opaque, but Vanguard is one of the few companies that earned my respect over the years. It is difficult to earn my respect and very easy to lose it. I’m holding a significant portion of my portfolio in Vanguard ETFs and I trust them to be acting the best interests of the shareholders. Reason 2: Diversification Vanguard Global ex-U.S. Real Estate ETF offers investors excellent diversification through having a total of 632 holdings. Only 23.1% of the value of the ETF was invested in the top ten holdings. Only two countries represent more than 10% of the portfolio, those are Japan at 22.7% and Hong Kong at 10.8%. Reason 3: Correlation My other international investment is the Schwab International Equity ETF (NYSEARCA: SCHF ). In my opinion, SCHF is one of the best international investments available today. I’m adding to my position in SCHF to increase the international exposure of my portfolio. Vanguard Global ex-U.S. Real Estate ETF offers moderately high levels of correlation with the Schwab International Equity ETF. However, most diversified international investments show high correlation to each other. Compared to the level of correlation that I see on other international funds, the correlation for VNQI isn’t too bad. Reason 4: Bid-Ask spread When you’re buying into a position in an ETF, you’re usually stuck paying the spread. If you intend to hold the investment indefinitely, you may only need to cross the spread once. Even if you only cross the spread once, it can be a meaningful reduction in your portfolio value if the spread is significant. As I have been writing this article I checked live updates on the bid and ask for VNQI a couple times. I’ve seen the spread range from $.01 to $.03. Share prices were running around $57, so we are looking at a range of around .02% to .05% being lost to the spread. Over the long term, it is usually assumed that you would lose half the spread going in and half the spread going out. I don’t like selling long term investments with solid dividend yields, so when I buy an ETF I intend to hold it for a long time. If you don’t want the ETF in 2025, why buy it now? Reason 5: I love dividends This ETF is offering solid yields on the portfolio which is the antithesis of the negative yield on ADRs. If an investor is investing for the long term, they would be wise to look at the yield they are buying and focus on acquiring income that is both respectable in volume and highly diversified in nature. That makes VNQI a very reasonable addition to most portfolios. It offers a strong yield to go with heavily diversified holdings. Conclusion When investors need international exposure, VNQI is one of the solid options to do it. There are several factors for the ETF and only a few against it. In my opinion, the biggest drawbacks are the expense ratio and the exposure to China (around 8.28% in China). The expense ratio of .24% is much lower than competitors offering international REIT exposure, but it is also much higher than the expense ratios on any of my other ETFs. Different people build their wealth in different ways. My method was being very frugal with my money. One way that I demonstrate that frugal stance is in limiting my exposure to high expense ratios. I’m not as big on the exposure to China because I think the Chinese economy is in a bubble and I don’t want that bubble in my portfolio. To avoid that bubble, my new holdings for international exposure (outside of dividend reinvestment) will be made in the Schwab International Equity ETF. I’m more comfortable with SCHF’s allocation by country than I am with VNQI. Even though I’m focusing on acquiring more SCHF, I’m going to continue holding my shares in VNQI. I think VNQI is a solid choice for part of the international exposure in the portfolio of a tax advantaged investor. Disclosure: The author is long VNQ, SCHF. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.

Debt Ratios And Pension Ratios: Connecting The Dots Between Them

A company with too much debt is like a tall vase with a narrow base. Everything looks fine until you kick the table, at which point it falls over and explodes into thousands of pieces. In an attempt to avoid companies that might explode, I always look for those with “prudent” amounts of debt. At the same time, I try not to be so restrictive that I can’t find anything to invest in. Avoiding companies with too much debt Over the years, I’ve defined “prudent” in several different ways, but my current rules of thumb for interest-bearing debts are: Only invest in a defensive sector company if its Debt Ratio is less than 5 Only invest in a cyclical sector company if its Debt Ratio is less than 4 (doesn’t apply to banks) The Debt Ratio , for reference, is the ratio between the company’s current total borrowings and its 5-year average post-tax profit (preferably normalised or adjusted profits). There is no magic to this; it’s just an approach which I’ve found to be reasonably good at differentiating between companies that are going to run into trouble because of their debts, and those that aren’t (I think I first read it in “Buffettology”, a book I highly recommend). Another financial obligation I’ve kept an eye on for the last few years is defined benefit pension schemes. Many companies don’t have one, but if a company does have one then in most cases (possibly all) it is legally obliged to ensure the pension scheme is well funded. If the pension scheme’s assets do not cover its long-term liabilities, the scheme will have a pension deficit and the company will have a legal obligation to close that deficit at some point. That will often mean shovelling cash into the fund, which means less cash for dividends or other things that create shareholder value. Avoiding companies with excessively large pension obligations I have a rule of thumb for pension obligations as well, just because I like to systemise my decision-making as much as possible. The rule is: Only invest in a company if its Pension Ratio is less than 10 The Pension Ratio is more or less the same as the Debt Ratio, only this time the company’s total defined benefit pension obligations are compared to its 5-year average post-tax profit. So far I’ve always looked at the Debt and Pension Ratios separately; I guess because I never thought about joining the dots, and because I haven’t seen anyone else look at debt and pension liabilities as two sides of the same coin. But last week, when I was reviewing my latest sell decision (June was a “sell” month for me), I noticed that the company in question ( Serco ( OTCPK:SECCF ) ( OTCPK:SECCY ), which I’ll write about soon) had both high levels of debt and a relatively large pension obligation. Specifically, Serco had a Debt Ratio of 5.2, which is too high according to my rules of thumb (Serco is in a cyclical sector and should have, by my rules, a Debt Ratio below 4). That alone would be enough to make me avoid buying the company, although not enough to make me sell it. It also had a Pension Ratio of 8.2, which is okay according to my Pension Ratio rule of thumb, but it’s pretty close to the limit of 10. That got me thinking. What if Serco had a slightly lower Debt Ratio? What if its Debt Ratio was 3.8 and its Pension Ratio was 8.2? That would be “okay” according to my rules of thumb, but is that a sensible outcome? Treating debt and pension obligations as interdependent risks If a company carries interest-bearing debts, then it will need to use cash to pay the interest on those debts. On the other hand, if a company has a large pension obligation then it either has, or could potentially have, a large pension deficit, and that would also require large amounts of cash to clear. Since there is only so much cash to go around, I think it’s sensible to look at these two financial obligations together, rather than in isolation. I don’t have some magical answer that will tell me exactly what a prudent amount of debt is for a company with a particular pension liability, or vice versa. However, I can take a reasonable guess, and refine it from there with experience. So my first stab at a rule of thumb which treats debt and pension obligations as if they impacted one another (because they do) is this: Only invest in a company if the sum of its Debt and Pension Ratios is less than 10 It isn’t rocket science, but I think it’s a good place to start. If, for example, a company has “medium” levels of debt, with a Debt Ratio of perhaps 3, then I would buy it (after a detailed analysis , of course) if its Pension Ratio is below 7. Or, if a company has a pension ratio of 8 then I’ll only buy it if the Debt Ratio is below 2. I think that should give me a fair balance between ruling out companies with excessive obligations, without being so restrictive as to rule out companies that are perfectly capable of handling their current situation. Of course, you may or may not use the same ratios as I do, but even if you don’t, I think treating debt and pension obligations as interdependent risks is still a sensible thing to do.