Friday, July 15, 2011

Investing Solo – Sweet Spot for Closed End Funds

The recent Fed statement that I interpret to mean that it will not be raising the short term interest rate for the foreseeable future, coupled with the futures market projection that the first significant hike will occur in about 18 months, and a mild one at that, has led me to start raising the portion of my portfolio held in leveraged closed end funds, which can borrow at short term low rates and invest the proceeds.  I’m looking to go as high as about 15%, depending on the opportunities as they arise, from a starting point of about half that.

I’m interested mostly in increasing CEFs on the debt side, with the exception of those that hold MLPs. I am skittish about stocks given the poor intermediate term outlook for the economy particularly in light of the massive federal debt and the uncertain business environment created by the Obama administration, the long term lower spending by consumers as they reduce their own debt in the face of uncertainty, and the 10-year Shiller P/E that suggests that stocks are currently overvalued. There have been long periods of time where the return on stocks has been flat or negative, inflation adjusted (e.g., roughly 1965 to 1982 and the last 10-11 years or so), and there seems to be no reason the current price stagnation can’t last for many years to come. I like investing for total return, to be sure, and I think investing for current yield is generally the best way to accomplish that.

My current CEF portfolio follows. I’ve been adding to these positions as opportunities arise – dips in price and discount, and with certain uncommon special exceptions, I'm particularly attracted to those from large, reputable portfolio managers whose trailing net investment income exceeds distribution with positive undistributed net investment income. The specific funds I have, when there are others in the category and fund family, were/are determined by the various relative metrics plus relative discounts on the day of purchase.

>> Municipal Bonds: The sweetest spot of all given the recent default fear in this market segment. Taxable equivalent yields at the 35% rate are above 10% on a slew of issues. Right now I have significant holdings of only Nuveen funds: NPM; NPF; NXZ; NVG; and NEV. I was out of muni CEFs entirely at the beginning of this year when the price drop on the default scare created bargains too good to pass on, and I now have substantial capital appreciation as well as great yield. The share prices may still have room to go if higher taxes are in the offing.

>> Mixed/go anywhere: I hold three CEFs from Pimco, whose CEFs are almost in a class by themselves given the very active portfolio management, high premiums to NAV, and significant monthly under-distribution coupled with year-end specials (link). I have significant holdings of PFN and PFL, currently distributing 7+%, which hold more corporate debt than anything else, and PKO, now at 8+%, which has more of a focus on asset-backed securities. I’m contemplating paring PFL given the large run-up in premium to NAV since Bill Gross, the port manager, mentioned it in Barron’s in June, and swapping for PKO or PFN, depending on the numbers at the time.

>> Preferreds (equity pfds & debt hybrids): Distributions are 7-8%, up to about 9% TEY, and I am holding my positions in JPS and JTP (link). I’m not adding more to this sub-class right now out of concern about the rate of redemptions coupled with the run up in price in the individual securities with which funds must deal.

>> Mortgage-back securities: CEFs vary a lot in the amount of residential agency versus non-agency, and the amount of commercial and other asset-backed debt, and of course in overall credit worthiness. My largest position is FMY, currently distributing over 9%, which is IG and mostly agency. I also hold some HTR (whose management has just also taken over FMY) and a little DMO and JLS, all currently at around 8% or better.

>> Foreign debt: I have modest holdings of GDO (more toward IG) and EHI (more junk), both over 8% right now.

>> Floating rate: This category consists of funds with floating rate senior secured bank loans, plus GFY (link) which I hold as well. I have significant holdings in JFR, BHL, and TLI, distributing now 5.5 to over 6%.

>> MLPs: I like the prospects for this group -- I have a substantial allocation to KMR, the stock version of KMP. I also hold CEFs KYN, KMF, and NTG, all now yielding 6-7%.

>> Stocks: I generally disfavor CEFs as vehicles for stocks, especially since so many follow an options writing or dividend capture strategy. I have one modest holding in this category, one which uses preferred stock for funds for leverage and holds utility stocks – UTG, currently distributing almost 6%.  I also have a nominal starter set in UTF, which holds infrastructure stocks like utilities, pipelines, and toll roads, and currently yields over 8%.

>> Real Estate: I have been out of this asset class for a very long time, but on a recent dip I have just established a small starter position in the CEF IGR, whose holdings are about 45% outside the US and currently distributing about 6.5%.

Mike Parenti

All Investing Solo Posts

I’m an individual investor with no background in finance or securities, writing things down to help organize and clarify my thinking. Of course, nothing I say constitutes investment advice of any kind – merely an account of my personal observations and decisions. My core portfolio is a conservative and diversified mix of equity and debt mutual funds, ETFs, and some closed-end funds (CEFs) across investment styles, management firms, and accounts, and I invest a relatively small amount (about 10%) somewhat more aggressively in the perhaps ultimately futile pursuit of alpha.

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