Co-produced with Treading Softly
With 2022 well underway, I wanted to take a moment from the madness to highlight two of my biggest portfolio positions. These are positions that I expect will treat me and other income investors very well.
Would I build a portfolio of just two holdings? No. How about five? Nope!
My long-time readers will know that I have carefully crafted my method of income over decades of experience in the financial industry – as a commercial banker – as well as in market investing. One of the rules in my income method is the rule of 42, setting a goal of a minimum of 42 positions in an income portfolio. This offers protection against the bankruptcy of any company and the reduction of its dividend. That being said, these two picks are two of the largest positions in my entire portfolio – they don’t make up my entire portfolio on their own.
I invest for income – reliable, stable, regular and recurring dividends. I love capital gains as much as the next person, but not at the risk of giving up great income. In 2022, with the added uncertainty and stress many of us face. It’s nice to have a comforting soft bed to curl up in each night and sleep surrounded by the security it provides.
Isn’t it nice? You can have it too!
Let’s dive into it.
Choice #1: PFFA, yield 8.2%
Virtus InfraCap U.S. Preferred Share ETF (PFFA) is an ETF (exchange-traded fund) that has certain characteristics that make it more similar to a CEF (closed-end fund). Many ETFs operate on a formula; they have a predetermined formula that informs about the shares bought and sold. There is no human analyzing anything or making decisions.
PFFA is different because it is a managed ETF, where management works to actively identify opportunities and makes decisions that may diverge from the index.
We can see that this active management, combined with the use of modest leverage, has made a huge difference for shareholders over the past year.
The recent spike against the general downward trend in preferences was due to management identifying South Jersey Industries, Inc. 8.75% Equity Shares (SJIV), a convertible investment that hit the bull’s eye with the acquisition announced by the Infrastructure Investment Fund. PFFA was overweight SJIV as the largest single position, which is now up over 26% year-to-date.
These types of opportunities and decisions cannot be reproduced by a passive formula. It takes human intelligence to recognize the value of the company, to recognize that it is materially undervalued and to decide to have an overweight position.
Among PFFA Top 10we see several farms that are HDO favorites.
The PFFA had a bias for exposure to convertible preferred stocks, “split” convertible bonds that cannot be called, and high-yield preferred stocks. All of these have proven to be much more durable as the market fears rising interest rates.
PFFA’s investment style is strongly aligned with HDO, making it our go-to ETF for expanding our exposure to preferred shares.
Choice #2: ECC, 12.5% efficiency
Eagle Point Credit Co, Inc. (ECC) is a CEF (closed-end fund) that invests in “CLO” shares – CLOs are collateralized loan obligations. These are bundles of senior secured loans which are then ‘securitised’. Investors can buy a tranche by seniority. The AAA brackets are paid first, and only after they are fully paid are the junior brackets paid. The “debt” tranches come with a predetermined yield. The “equity” slice gets all that’s left. Although it is called ‘equity’, it is backed by senior secured loans. The structure looks like this:
The equity of the CLO has a excellent historical recordonly 4% of the returns of “CLO 1.0” shares being negative.
This despite the great financial crisis which caused a sharp increase in payment defaults. CLOs have proven to be very resilient.
In 2020, ECC saw several CLOs it held have “redirection” provisions triggered. These provisions prepay the senior tranches in times of difficulty. The cash that would have been used to pay the equity tranche repays the senior tranches instead. Note that borrowers of the loans still have to make the same payments, so while this reduced cash flow in 2020, as default rates remained low, those equity positions are paying more today.
ECC Cash Flows are now well above 2019 levels, which ranged from $1.02 to $1.13/quarter. ECC increased its dividend, only because taxable income was high enough to force it to do so. The rest of the excess cash flow was reinvested, taking advantage of the buying opportunity.
Basically the ECC is in much better shape than it was before COVID. Cash flow is 30% higher per share, its net asset value is 25% higher per share than in December 2019, and default rate expectations are much lower. Despite all this, ECC is trading at a lower price!
ECC offers double-digit yield today, will likely pay a special dividend in 2022, offers excellent prospects for dividend growth and potential for capital gains. It is rare to find all of this in a single vine, and even rarer to find it with a yield of 12% to begin with!
By investing in great preferred stocks – through PFFA – and investing in the belief that the US economy will continue to strengthen – through ECC – we can generate high levels of immediate income. We are also the creditors of American companies. We are not responsible for the debt, we own the debt. This allows us to have a higher degree of security, while enjoying significant revenues. This way, the market takes care of your finances.
Imagine the free time you will have unlocked when you no longer have to worry about your finances. Money can be a difficult topic to talk about, especially when you don’t have enough to cover your expenses. By changing the way your portfolio is invested, you can get even more income from your portfolio.
The retreat then becomes more relaxing. You will have more flexibility. Want to grab that ice cream cone? Dark. Want to adore your grandchildren? You have the ability to do just that! A dream vacation in Italy and seeing the Colosseum? You can accumulate this extra income to pay for exactly that.
This is income investing. It is financial freedom. It is at your disposal. The choice is whether you will take it. are you going