Income Investors Shouldn’t Panic

By: ,

We have gotten a number of notes from readers concerned with their portfolios–not surprising, as perpetual preferreds, exchange traded debt and REITS have been severely hammered this week.  The REIT selloff is simply a continuation of a sell off that started a month ago and stems from higher interest rates which make borrowing costs higher for real estate firms.

The Trump victory this week has caused a huge dislocation in the bond markets as uncertainty in his potential policies on trade (i.e. tariffs on foreign goods coming into the U.S.) and domestic infrastructure borrowings has caused caution on a global basis.

From the past we know that the level of interest rates is only 1 factor in the current pricing on perpetual preferreds and long duration exchange traded debt issues.  As importantly as the level, is the speed at which rates move higher–moves of 10, 20 or 30 basis points a day are deadly for short term pricing on these securities.  We also know that the issues with the lower coupons (higher quality issues) will be hammered the hardest as investor unload the lower coupon issues to reposition in higher yielding issues.   These are truisms that have held true for at least the last 10-15 years (the length of time we have invested in these instruments).

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For many investors that are heavily invested in perpetuals and long duration exchange traded debt issues (baby bonds) the issue is that they maybe haven’t defined  what they are trying to accomplish–what are their expectations. All investors in these instruments need to understand that when interest rates move higher prices will move lower.  This is NOT a problem if the investor is investing for income with the understanding that their capital asset value will move around, but the monthly income stream is their paramount concern.  The income stream remains the same even if the share price falls.  This should be what income investing is all about.  The days of CDs with yields of 6% are way behind us (and may be way in front of us) and it requires capital risk to garner 5, 6 or 7% dividends.

So as we wrote about earlier today if you liked a security at a 6% yield you should love it at 7% and maybe should consider buying more.  On the other hand if you are laying awake nights worrying about what is happening with your investments maybe you need to lighten up your positions a bit and reconsider what your goals are for the future.

For ourselves we try to concentrate on ownership of term preferreds and exchange traded debt issues with maturity dates in the next 5 years or so.  Because there is a “date certain” when the issue will pay your principal back to you the share price tends to be much less volatile.  We have stressed the need to pay attention to the duration of the instruments that you are buying because it was only a matter of time before interest rates moved higher.  We publish a list of securities that have maturity dates in the next 12 years–it can be found here (it is slow to load and is 2 spreadsheets).  This list has generally moved only modest amounts during the last week or so–a fraction of the movement of perpetual preferreds.

For the weeks ahead we would think that interest rates would stabilize at the current level (2.12% on the 10 year), although no one knows for sure. We think it is likely that prices should stabilize in here–and maybe move a bit higher as markets calm a bit.

Nothing above should be construed as a recommendation to do anything in particular in your investing–only you can determine the level of risk you wish to incur.  Each investor is different and unique–some like high risk and high reward while others are satisfied with very modest returns which is commiserate with lower risk.

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