Unloved In The Marketplace, Savvy Senior ‘Income Growth’ Portfolio Increases Cash Flow Payout
“Total return” results have been nothing to brag about for this author and many others focused on income and dividend investing in recent months. But through re-investing and compounding, my 10% yielding portfolio has increased its income flow by 14.7% from a year ago. In other words, the “income factory” continues to expand its output, even while the factory itself has seen its market price drop, making re-investment even more attractive. I would worry if I thought the income factory were worth less in an economic sense, but it is not. A lot of what is spooking markets these days (the Fed, Greece, Puerto Rico, inflation) is just noise. From a total return standpoint, it has been a tough first half in 2015 for many dividend-focused investors, including me. Fortunately, I focus on what my “income factory” produces, and not how the market values it from day to day or month to month. From that standpoint, the news is positive since “factory output” (i.e. income) continues to increase steadily, and I can re-invest that output in additional machines (i.e. income-producing assets) at bargain prices. To be specific, the cash income my factory produced for the first 6 months of 2015 was up 14.7%, higher than the cash income it generated during the first six months of 2014. The six-month cash yield was 5.1% (10.2% annualized) versus a total return that was just barely positive at 0.2%, so without the cash distributions, the return would have been a negative 4.9%. In a practical sense, having a 10% dividend stream that I can re-invest in assets that have essentially been “on sale” for the past nine months is a great opportunity and accounts for my income stream increasing at the rate it has. Since the end of the quarter (June 30), market values have dropped even more, so my current total return year-to-date as we go to press is a bit lower (minus 1%). I mention this in order to compare it to a few useful benchmarks that also report on a year-to-date basis: · Vanguard Dividend Appreciation ETF (NYSEARCA: VIG ): YTD total return of 1.6%, with a yield of 2.24% · Vanguard High Dividend Yield ETF (NYSEARCA: VYM ): YTD total return of -1%, with a yield of 3.26% · ProShares S&P 500 Dividend Aristocrats ETF (NYSEARCA: NOBL ): YTD total return of -.27%, with a yield of 1.85% · SPDR Dividend ETF (NYSEARCA: SDY ): YTD total return -2.32%, with a yield of 2.37% · Vanguard Wellesley Income Fund (MUTF: VWINX ): YTD total Return of -0.4%, with a yield of 2.7% · Vanguard Wellington Fund (MUTF: VWELX ): YTD total return of 1.05%, with a yield of 2.4% In short, it’s been a tough quarter for balanced fund or dividend growth type investors, with mostly flat or slightly down results. The poor total returns are offset, of course, by the ability to compound dividends. But that’s limited if you’re only earning 3% or 4% yields like so many “dividend growth” portfolios. That’s why I’m pretty satisfied at this point with my “income growth” strategy (that many readers are familiar with from past articles, like this one , and this one ) that focuses on growing the income stream through compounding high cash distributions (8-10% or so), and does not rely on organic growth (dividend increases) or market value appreciation. The potential “fly-in-the ointment” in a strategy like mine would be if the decline in market value were a genuine signal of a drop in the income generating potential of a particular asset. So we have to ask the question: · Is the current drop in prices, especially for high-yielding assets like utilities, high-yield credits, and leveraged closed-end funds and other vehicles, a sign that the high yields these assets generate are in jeopardy? · Or are they more a reflection of the “nervous Nelly” quality of the equity markets, where concerns about various issues can translate into selling pressure in unrelated markets and asset classes. I subscribe to the “nervous Nelly” view and believe that markets are seeing negatives that don’t actually exist or are not relevant to the high yield and leveraged markets. Some examples: · Concern about Janet Yellen and the Fed raising interest rates. First of all, when the Fed finally does raise rates, it is likely to only be 50-100 basis points, if that. While that may send a signal that the economy is “normalizing” and that the artificially low interest rate era may be ending, it is hardly enough to hurt leveraged closed-end funds or most other leveraged vehicles. So a closed-end fund that is borrowing at 1% will now have to pay 1½% or 2% instead. If they are using the money to invest in loans, bonds or preferred stock, etc. paying 5%, 6%, 7% or more, it is still a good deal. Meanwhile, the rates on what they are buying will likely go up as well. · All bonds are not created equal. Rising interest rates tend to hurt long-term, fixed-rate, government and investment grade corporate bonds. That’s because these bonds have a relatively high duration and most of the interest coupon an investor receives is payment for taking interest rate risk, not credit risk. High yield bonds, leveraged loans and many other high-yielding instruments often have shorter durations and the coupon represents payment for taking credit risk, not interest rate risk. The irony is that many of these assets actually do better when interest rates increase because the rising rates are a sign of an improving economy, which tends to improve credit performance. Credit performance, rather than interest rate risk, is the main factor in portfolio performance of high-yield bonds and loans. (Loans, by the way, are floating rate, so they have virtually no interest rate risk at all). · Concerns about inflation. In general, I do not see inflation as a medium- to long-term threat the way it was 30 years ago. The main reason is the globalization of our economy, including labor markets. Merely living in a developed country no longer guarantees you a developing country level wage anymore, now that companies can move jobs – actually and virtually – all over the world. This will continue to keep wage inflation down in the United States for years to come. This in turn will have a moderating effect on interest rates. · Other negatives – China’s stock market meltdown, Greece’s economic and political problems, Puerto Rico’s insolvency – may make headlines but are unlikely to affect the ability of the companies in our various fund portfolios to meet their obligations and maintain those funds’ cash flows. So those are the various negatives that I’m NOT particularly worried about. On the positive side, I am happy that the economy continues to make steady forward progress. I don’t need it to race ahead, since I’m not looking to the stock market to appreciate for my strategy to work. I just want the hundreds or thousands of companies whose stock, bonds, loans and other securities are owned by the dozens of funds that I own to keep on paying and continuing to provide the cash flow that my funds distribute. I have not changed my basic portfolio much at all from three months ago, and you can see it in my April article here . A few tweaks included: · Selling off a portion of my Cohen & Steers CEF Opportunity Fund (NYSE: FOF ) when it reached a market high a few months ago. It’s a great fund, and I’ve been buying back in now that it’s at a lower price point and yielding 8.7%. · Started adding Babson Capital Participation Investors (NYSE: MPV ) as a solid “buy once, hold forever” sort of investment. It has been managed by Mass Mutual Insurance since 1988, with an average annual return over that time of over 10%. It holds “private placements” which are the fixed income “bread and butter” of the insurance industry, and Mass Mutual is a long-time professional at it. The shares sell at a 9.7% discount, well below its typical 4% discount, and it pays a distribution of 8.6%. · Added to Reaves Utility Income Fund (NYSEMKT: UTG ) as its price came down and yield went back up to 6.25%, which is high for this excellent fund that many of us here on Seeking Alpha have liked and held for many years. · Added to Duff & Phelps Global Utility Income Fund (NYSE: DPG ); good solid holding in the utility sector; great opportunity right now at almost 14% discount, 8.2% yield. · Added to Blackstone/GSO Long-Short Credit Income Fund (NYSE: BGX ); good solid floating rate loan fund at 14% discount with 7.6% yield; excellent managers. I continue to watch some of my higher volatility holdings like a hawk. Oxford Lane Capital (NASDAQ: OXLC ) and Eagle Point Credit Company (NYSE: ECC ) continue to bounce around price-wise, but still make their regular distributions, with yields of 16.7% and 11.8%, respectively. They both are challenging to analyze and understand, but the bottom line is that both seem to have plenty of cash flow (which in their world of CLO investing is different than GAAP income) to make their dividend payments, so I am happy to have them in my portfolio. All my high-yield bond funds are underwater, but for reasons mentioned earlier in the article, as an asset class they seem to be in no economic danger of not being able to meet their distributions, so I am inclined to hold them. In fact, the improving economy should help them. If I were not already an investor, I’d be buying into the asset class, just as I did in 2008 and 2009. (When there’s blood in the streets, you buy, right?) That’s about it. “Steady as you go,” is my mantra. Keep re-investing those dividends. Disclosure: I am/we are long BGX, MPV, UTG, ECC, OXLC, DPG, FOF. (More…) 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.
