Difficulties for Income Investors Continue
By: Tim McPartland,
When the year began we had stated that the year was likely to be a difficult one for income investors as we fought with the negative affects of rising interest rates. After stellar performance through the first couple of months of the year, with our Blended Model Portfolio up as much as 4.7% as interest rate increases were continually pushed out, we find ourselves struggling to maintain a 3% YTD gain at the end of July. We knew it was going to be tough, but starring at the start of a interest rate hiking cycle the appreciation of how difficult the next year will be is just hitting home.
We have done much of the work that we can do to soften the impact on our portfolios, but obviously we need to do more. We have moved out of most of our perpetual preferreds (and this hasn’t been the area that has been difficult–YET) preparing for more difficult times ahead. We have avoided upstream MLP’s which have gotten pounded down relentlously. We have been underweighted in REIT’s, but just the same they have not treated us kindly. We only own 2 Canadian issues–1 is breakeven while the other has been knocked down because of the strong dollar. The 2 closed end funds we own have done ok–fortunately we had good entry prices so we haven’t been decimated as many CEF holders have been in the last year. Our term preferreds and exchange traded debt have done well and we are more than happy with those particular holdings.
On the topic of Closed End Funds (CEF’s) we have to add a word of caution. We have noted that many income investors have been flocking to CEF’s for their very tasty current yields. I can’t think of a worse place to be moving into at this point in the cycle then CEF’s. Let’s look at an example of where the Pimco High Income Fund (ticker:PHK) has been over the last year.
As you can see the market price of this CEF is down over 20% in the last year, but a investor has ‘recovered’ a good part of their loss in distributions (around $1.45/share), which leaves the investor down by near 10% for the last year and we have not entered a tightening cycle. In fact the 10 year treasury was at 2.50% a year ago and is now around 2.40%.
The current price of PHK is a premium to Net Asset Value (NAV) of 25%. This is kind of crazy! We realize that the Pimco funds have traded at premiums for years, but do I want to invest in a CEF that is likely to take a deep dive when the first interest rate hike comes along. Hell no!! Do we want to leave our portfolio net asset value in the hands of investors that are likely to panic when rate increases come along? Hell no!! While todays $9.15 share price looks good these same shares were under $4 in 2008/2009 when investors panicked—that is the time to buy–not now.
So what will we do? We are going to sell our Oriental Finance Group preferred (ticker:OFG-B) which is a Puerto Rican banking company and while we don’t think they are at high risk with the Puerto Rican debt crisis we see no reason to hold on and incur the risk (were already have taken a significant loss in these shares). In addition we will sell 1 of our CEF’s– Pimco Opportunity Fund (ticker:PKO), which even though it sells for a discount to NAV, there is no use waiting for interest rate hikes to kick in.
These moves will move the cash position in the Blended Income Portfolio to around 14% and in these most dangerous times this is a reasonable level.