I thought I would update my investment approach, since my
last post on this was about a year ago.
Then, I thought the time was a sweet one for Closed End Funds (CEFs),
and a year later I think that’s still true, maybe even a bit more than before.
My approach is one of investing in light of the
intermediate-term market and economic macro picture. I don’t think of this as market timing, as I
don’t trade for short-term profit. I
think of my approach as one of strategic asset allocation. Right now I think the intermediate-term macro
picture is one of (1) substantial deleveraging at the state and individual
level, and (2) the boomer reach for yield in the face of a long-disappointing
stock market and growing skepticism of the “stocks for the long run” approach,
as the lead edge of that demographic is now reaching retirement age.
I think that consumer and government financial retrenchment
combined with less demand for stocks as investments will lead to continued
economic and stock market weakness for years to come, which in turn will result
in low interest rates (as seen in Japan for the last 15 years or so) and reasonable
demand for quality debt (“fixed income”) assets for many years. One can only invest consistent with some
assessment of market prospects, and that’s mine. Whether the US economy is technically in a
recession versus being in a very low growth state seems immaterial, other than
for its potential psychological effects on investors and the possible
government actions it provokes.
As a result, I have gradually moved my portfolio even
stronger into leveraged CEFs, which borrow at short-term interest rates and
use those extra dollars to invest in more securities to generate higher returns.
The leverage is modest by financial wheeler-dealer standards – at most,
one borrowed dollar for every one of investor equity, so that the maximum
leverage as a percent of total assets cannot be greater than 50%, and usually
is between 20 to 40%. In this
environment, as Bill Gross has said and written, why not act like a banker and
borrow at low rates and lend at higher ones?
For me right now, the risk of a carefully-selected leveraged
CEF that yields 6% to 9% is acceptable in this environment. I don’t want to sit by earning 2% to 5% on a
fully investment grade vehicle with inflation running, let’s say, 2%. I’m willing to study my CEF options and take
the risks, which I ameliorate somewhat, beyond ongoing due diligence, through
diversification across types of funds and sponsors. CEF portfolio managers have tools available (derivatives) that they can employ to cushion the effect of rising short-term interest rates, when that eventually begins to happen.
I now have a majority of my portfolio dollars in leveraged debt
CEFs, earning a much higher return than I would without them. Some of my largest holdings include: PFN and PKO (both Pimco) with diversified debt; KTF (DWS) and NEV
(Nuveen) with tax-free muni bonds; TLI
(Legg Mason) and JRF (Nuveen) with
floating rate senior secured bank loans; FFC
(Flaherty & Crumrine) and JPS
(Nuveen) with preferreds/exchange-traded debt; DMO (Legg) with mortgages; and GBAB
(Guggenheim) with taxable Build America muni bonds.
The only CEFs I hold with equity are in the midstream
energy/MLP space (i.e., pipelines and storage). My largest positions
are KYN and KMF (both Kayne Anderson) and NTG
(Tortoise).
A caveat: I thought these CEFs were good buys when I
accumulated shares, and I still like them here at least as holds. In recent months, CEF prices, and those of
other debt instruments, have been bid up in the reach for yield, and as such
most of my funds are trading at modest to moderate premiums right now. Whether they are good buys right now, or at
any time, and particularly relative to other CEF choices, is up to each
investor to assess.
Outside of CEFs, in light of my macro picture, I have by now
exited all my floating-rate preferred securities, such as MET-A and MS-A, that
I had begun accumulating in 2010 and early 2011. Non-midstream energy MLP-related equities are
now less than 10% of my total portfolio.
Mike Parenti
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