Wednesday, August 11, 2010

Attention Income Investors

For those of you who have a bad case of vertigo with the market volatility, whether your 21 of 55 years old I've got a few holdings that have low beta's (how much they move in tandem with the market - 0 = unaffected by market moves 1=matches the market, 2=twice as volatile etc), earn 2-6 times the the 10yr treasuries. Perhaps just as important is that while bond investors have been on the right side of the market compared to equities this year, if/when the economy finally recovers, bond prices will decline as yields rise and you'll give all that back and more. If you look at bond prices, they're at all time highs, meaning yields are at all time lows (except perhaps for the junk category). Buying a bond right now has an extremely high probability of a negative return over the next 5 years. I'm going to give you some other assets with lower volatility and higher yields with the opportunity to raise their yields through better income in a recovery.

First thing - MLPs (Master Limited Partnerships) - usually pipelines that have long term contracts on transporting natural gas and oil therefore their income streams are steady. Because they're a tax beneficial part of the tax code means they pay out substantially all of their profit. The net result is you get a stable earnings yield and 90% of it is paid out quarterly via dividends. I would own more than just one to stay diversified, and it pays to investigate where their pipelines are centered to make sure you don't get over concentrated in a certain area of the market which might be subject to gluts or shut-ins. Most MLP's sport 6-10% dividend yields - nothing to sneeze at in the low interest rate world we live in

Try a few of these:
ETP - Energy Transfer Partners. Has a 0.53 Beta, and a 7.61% yield at current price.

TCLP - TC Pipelines. Has a beta of 0.47, and 7.12% yield at current price.

WPZ - Williams Pipeline Partners. Beta of 1.25, but only because its been on an upward tear due to debt restructing. Its off its recent 52 week high and yields 6%.

EPD - Enterprise Product Partners. Beta of 0.54 and yields 6.3% at current price.

The second place we go is into the preferred security world. Typically representative of common stock, but slightly higher in the debt tier ladder than common stock, these move less than the common, but often support higher dividend yields than common. We're looking for lower volatility and higher yield with some appreciation potential - these securities fit the bill. Because it can be difficult to buy and sell individual securities as their volumes are light, its best to get an index.

Try this:

PFF - Ishares Preferred Stock Index. Also recently off its 52 week high, it has a bit higher beta than MLPs at 1.02, but again this is because of the rapid appreciation. This pays a variable dividend which is normally around 7-9% depending on the underlying securities distributions. The good news is it pays monthly so the income stream is steady. While this follows the financial stocks moves to an extent, it gives you the exposure and income mix that makes for a successful long term holding. Also, because its an index fund, its got a pretty low expense ratio.

Next thing you should look into is convertible bond funds and indexes. Convertibles pay a coupon like a normal bond, but they're typically apportioned a share conversion option if the common stock of the bonded company appreciates to a certain point. Because of this, the yields are slightly lower than regular bonds for the same company, but the yield remains attractive because most of the companies issuing the convertibles are smaller companies hoping to grow their share price enough to release them from the bond obligation. Because they're smaller, they're a bit more speculative than blue chips and therefore have a higher yield. A great way to play this is through a mutual fund (you want them to do the research on the bond ratings). Vanguard is pretty much unbeatable from an expense ratio standpoint and VCVSX is my recommendation.

Next is starting to look into multi-state closed end muni bond funds. Its important to look at the closed end universe because key to return here is buying when the discount to NAV is higher than normal. Purchasing at these points can give you a capital appreciation upon which to boost the coupon payments you will receive. They typically pay 5% (Tax free) which depending on your tax bracket could be a 6.5 taxable equivalent. If you buy at the right moment, you can get a 5-10% capital appreciation and you can sit on the holding for a year, collect the payments, then decide on whether to sell the holding as a long term gain and use the coupon payments to offset your taxes. Nuveen has many Muni-bond funds and will show you the discount to NAV on a daily basis so you know when to buy. Key is to buy when its 4-5% than the normal discount, betting it will soon return to normal. Please note these can be often thinly traded and so can go up or down a good bit any given day, but you need to ignore the swings knowing that it hasn't anything to do with the underlying muni-bond securities which are typically non-volatile assets. Heck - if the fund dives - that's your signal to get in or buy more based on my thesis above. Try of NQM (beta 0.14), NPV (beta 0.11), NMY (beta 0.23).

Lastly, look into some closed end world bond funds and potentially some REITs. First Aberdeen has many - I like FAM for a world bond fund. Employ the discount to NAV strategy and you'll prosper similarly to the Muni strategy. Plus this one pays 8-9% with a beta of 0.76. The next time Greece looks like a nightmare or Hugo Chavez nationalizes another business - look for this fund for entry points.

That's enough for now - add some of these things to your portfolio and take some solace in watching your portfolio gyrations mellow, the cash pile up, and your alpha increase.

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