The need for Yield

[Steven B]

Yield. Yield. Yield. Everyone is searching for the elusive yield these days. Wanted to know what the board had to say about it, for instance do you believe that bonds are going to get destroyed with rising rates? What about alternative sources, say NNN REITS or online lenders such as prosper and lending club? Family members have given me their passive portfolios to manage along with the active part and they were in pretty vanilla 60/40s previously. Looking forward to hearing what y'all think.

[DTEJD1997]

Depending on the size and composition of the portfolios you are working with...one way to get some yield is to write covered calls.  I especially like doing this on stocks that have appreciated quickly and are at/above what I think to be "fair value".  For example, you bought a stock at 31, a few quarters pass and it spikes up to 44...you think "fair value" is 40.  Write calls at 45 or 47.50.

 

I would think that with some monitoring and a bit of hard work, you could EASILY increase the yield on your portfolio by 1 or 2 percent a year with minimal risk.

 

I've done this personally with generally good results...

[Pelagic]

I thought this was a pretty good piece that someone posted a couple months ago on BAC and WFC preferred stocks.

 

http://www.philosophicaleconomics.com/2017/03/a-value-opportunity-in-preferred-stocks/

[GregS]

I believe reaching for yield is dangerous.  High yield is a red flag for risk in any asset.  Yes, experienced investors can sift through that and find real gems but we're not talking about a passive strategy or anything for amateurs.  Seth Klarman's writing in Margin of Safety on distressed debt investing vs. junk bonds is a great illustration of this.  The real rewards from high yield investing come from re-rating of risk not the yield, IMO.

 

It's better to adjust expectations.  Govt and IG bonds are low yielding right now but there's little way to earn more without more risk.  Mix up duration so you can shift short term money to longer term bonds if rates rise, but pretty much everyone is doing this right now which is keeping rates capped.

 

If you are managing things actively, I think a dividend growth portfolio is a possibility.  There are plenty of ways this can go wrong, however, like holding financial stocks into 2007-08.  Retailers, REITs today maybe.  Current yields in the best companies are pretty low but if you expect them to grow, you can be earning decent yields on your initial capital in a few years.  You still need to get the business and stock right.  This is a long term, buy and hold strategy but not a buy and forget strategy.

 

I don't do options but you won't blow up writing covered calls.  You just have to know what you'll do in a sharply rising market if things get called away.  Reinvestment risk in a rising market is what you need to worry about.

 

 

[Steven B]

Thanks everyone for the advance. I'll try a mixture of those strategies and I'll definitely look into preferred, though I don't understand yet how those won't lose value as rates rise as well.

[winjitsu]

 

Yield. Yield. Yield. Everyone is searching for the elusive yield these days. Wanted to know what the board had to say about it, for instance do you believe that bonds are going to get destroyed with rising rates? What about alternative sources, say NNN REITS or online lenders such as prosper and lending club? Family members have given me their passive portfolios to manage along with the active part and they were in pretty vanilla 60/40s previously. Looking forward to hearing what y'all think.

 

Agree'd the reach for yield is incredibly dangerous, but from a institutional perspective there's a real need for consistent return above 5%.  Non-profits in the US "must distribute only their minimum investment return statuatorily defined as 5%," and that target becomes their minimum required return to maintain assets. Back when rates were higher, this was easy. Now not so much...

 

The hope is that these investors stop buying into high-yield junk, REITs and MLPs and go back into safer government investments as rates rise. As a result, I hope these asset classes come back to earth in terms of valuation.

 

 

 

[netnet]

if you are an accredited investor (or pooled your family is) you might look at private vehicles.  Specifically, some of my family is in alternative private real estate funds.  You have to be even more picky here, because of a lack liquidity, the bad ones are shall we say roach motels--once in you can't get out. 

 

That said the best ones have yields of 8 to 11%.  I have put elderly uncles and aunts in the ones I have liked.

[DTEJD1997]

Hey all:

 

If one is looking to pick up yield, I've done VERY well with BDC's.  Of course, they are higher than they were a while back...but some of them have backed down in price (and gone up in yield).

 

My favorite is Pennant Park (PNNT).  They had a bit too much in the oil field and related industries and got pinched.  They had to lower asset value, take some charges, convert debt to equity and so on.  THEY ALSO LOWERED THE DIVIDEND, which was something they didn't have to do in the big financial meltdown.  They also their management fees.

 

After the pain, they are slowly recovering and earnings are SLOWLY going back up along with NAV.

 

I am going to guess that if they can continue making progress, AND the economy doesn't collapse...they might raise the dividend and start charging their "normal" fees.

 

If that happens, the yield would go from 9.5% to well over 10%, heck, maybe even 12% or more.  Of course, you would also get a nice little bump in capital appreciation.

 

 

[rawraw]

My strategy has been to get exposure to higher yielding assets historically not available to retail investors. This has resulted in a portfolio of consumer loans in Lending Club and a small portfolio of real estate loans at Groundfloor. Lending Club would be my main answer to this if it wasn't so tax inefficient, so it naturally limits the opportunity outside of retirement accounts.

[NoCalledStrikes]

Tough analysis of PNNT at https://bdcreporter.com/2017/05/pennantpark-investment-revolver-amendment-baby-bond-repayment/  It reminds me why I generally don't buy BDC's.

 

[Packer16]

The two areas I like are BDCs who underwrite like banks (TSP Specialty (TSLX) is an example) & NNN REITs (Broadstone Net Lease being my choice - 6.2% yield plus with low teens total rates of return).  BNL has a public disclosure document with Edgar.  I agree with the negative sentiment on most BDCs as they underwrite like high yield or private equity guys versus bankers when a few default can erase a year or so of interest.

 

Packer

[DTEJD1997]

Hey all:

 

Yeah, you've got to be careful with BDC's.  A lot of them are simply not investable...but some are not too bad if you get a big enough discount...

 

Same thing with MLP's.  A lot are no good...but some of them are OK, especially if you got a big enough of a discount...

 

Who said, "There are no bad assets, just bad prices"?

[Jurgis]

Two questions in fixed income space:

 

1. Almost-cash with some yield. Should be not more than 1-2% annual fluctuation max. Something that could be liquidated in severe market drop without more than 5% loss under most scenarios. I hold ISTB. Any other suggestions with >1% yield?

 

2. Bond fund. Somewhere in 3-4% yield range, good past performance (preferably not a large 2008-2009 drawdown - yeah, this is way backward looking), good management, somewhat OK bond holdings and durations. Not stretching for yield. I'm looking at PONDX. Any other suggestions?

[Packer16]

IMO the BDC are not investible unless you know the underwriting that went into the investments.  I know of one, that I mentioned, that has a process I understand.  It only takes a few bad loans to lose a lot of interest payments & we have been through a relatively benign environment since 2009.

 

Packer

[chesko182]

Two questions in fixed income space:

 

1. Almost-cash with some yield. Should be not more than 1-2% annual fluctuation max. Something that could be liquidated in severe market drop without more than 5% loss under most scenarios. I hold ISTB. Any other suggestions with >1% yield?

 

2. Bond fund. Somewhere in 3-4% yield range, good past performance (preferably not a large 2008-2009 drawdown - yeah, this is way backward looking), good management, somewhat OK bond holdings and durations. Not stretching for yield. I'm looking at PONDX. Any other suggestions?

 

Hey Jurgis,

 

I work in Fixed Income strategy so might be able to help.

 

For #1 I like short investment grade floaters, which yield anywhere from 1-3% depending how much you extend the maturity. A lot of financial companies issue these bonds (BAC, GS, JPM, BRK all have) if you're looking to diversify there is an ETF that follows a short IG floater index called FLOT, check it out it yields ~1.5% pretty close to a 0 interest rate duration (meaning not sensitive to moves in interest rates, what actually matters here is 3mo LIBOR which would feed through as additional income as it keeps on rising which is my base case with ongoing Fed hikes...) and 2yr avg maturity

 

Of course that leaves you with the credit risk, but considering it's very diversified, investment grade rated and an ETF which makes it fairly liquid I would not expect this fund to fall more than 5% in a crisis, unless credit markets freeze completely of course (ala 2009)

 

Let me know your thoughts, I'll try to get back to you on the other one. Maybe a similar fund just with longer maturities could get you there. I think it makes sense to have floating rate exposure in the fixed income world at this point.

[Jurgis]

chesko182, thanks for your ideas. I'm traveling now. I'll take a look at FLOT when I return and get back if I have any thoughts.

[Packer16]

For short term bond type investments, CDs at Credit Unions are a good choice.  An example is Navy Federal Credit Union where you can get 3% on on the first $3,000 & competitive rates above that.  You may want to check out local deals in your area.

 

You may also want to consider I-bonds as they yield inflation plus almost 2% & have tax deferral until sale but you can only invest $10,000 per year.

 

Packer

[TwoCitiesCapital]

Yields are there - just not in the U.S. or Europe.

 

You can't get 5-7% yields from emerging market equities pretty easy. For us value investors, they're in the 16th percentile of their historical valuation range. Single digit P/Es, high dividends, and currencies that are undervalued by 7-10% on PPP basis - sounds good to me.

 

If you're not wanting to dive all in on emerging market equity, IG EM companies currently yield more than U.S. junk bonds. U.S. junk is trading tight to historical standards while EM IG spreads are 1-1.5% wide from their historical norms. European equities also have yields that are significantly higher than their U.S. peers, but less attractive than EM.

 

Seems like the 5-year bear market in the EM universe that appeared to end in 2016 is given investors plenty of reasons to not dive back in, but EM hasn't been this cheap in my investing lifetime so I'm loading up on it as it's one of the few places I see good value.

 

 

 

I'd consider a a bar bell approach if that type of exposure makes you uncomfortable. Hold some cash and hold some EM equity/bonds.

 

 

[Spekulatius]

What specifically do you find worth buying in Emerging market equities?

[BG2008]

Yields are there - just not in the U.S. or Europe.

 

You can't get 5-7% yields from emerging market equities pretty easy. For us value investors, they're in the 16th percentile of their historical valuation range. Single digit P/Es, high dividends, and currencies that are undervalued by 7-10% on PPP basis - sounds good to me.

 

If you're not wanting to dive all in on emerging market equity, IG EM companies currently yield more than U.S. junk bonds. U.S. junk is trading tight to historical standards while EM IG spreads are 1-1.5% wide from their historical norms. European equities also have yields that are significantly higher than their U.S. peers, but less attractive than EM.

 

Seems like the 5-year bear market in the EM universe that appeared to end in 2016 is given investors plenty of reasons to not dive back in, but EM hasn't been this cheap in my investing lifetime so I'm loading up on it as it's one of the few places I see good value.

 

 

 

I'd consider a a bar bell approach if that type of exposure makes you uncomfortable. Hold some cash and hold some EM equity/bonds.

 

Twocities,

 

Can you cite some specific emerging market names that are really cheap?  Thanks in advance. 

[TwoCitiesCapital]

What specifically do you find worth buying in Emerging market equities?

 

I've been buying funds for broad based exposure in addition the a handful of names that I already own and am adding too.

 

 

Yields are there - just not in the U.S. or Europe.

 

You can't get 5-7% yields from emerging market equities pretty easy. For us value investors, they're in the 16th percentile of their historical valuation range. Single digit P/Es, high dividends, and currencies that are undervalued by 7-10% on PPP basis - sounds good to me.

 

If you're not wanting to dive all in on emerging market equity, IG EM companies currently yield more than U.S. junk bonds. U.S. junk is trading tight to historical standards while EM IG spreads are 1-1.5% wide from their historical norms. European equities also have yields that are significantly higher than their U.S. peers, but less attractive than EM.

 

Seems like the 5-year bear market in the EM universe that appeared to end in 2016 is given investors plenty of reasons to not dive back in, but EM hasn't been this cheap in my investing lifetime so I'm loading up on it as it's one of the few places I see good value.

 

 

 

I'd consider a a bar bell approach if that type of exposure makes you uncomfortable. Hold some cash and hold some EM equity/bonds.

 

Twocities,

 

Can you cite some specific emerging market names that are really cheap?  Thanks in advance.

 

Russia is trading with a CAPE of 5x as a whole. Some names?

Lukoil - P/E of 8 with 7% yield

Gazprom - P/E of 3 with 6.7% yield

Sberbank - P/E of 6 with 4% yield

 

I'm sure there's a multitude more with the two dozen or so ADRs that trade, but I'm less familiar with the other names.

 

Brazil is cheap too - particularly after the recent re-opening of the political mess.

Vale - P/E of 7 with 4% yield

Santander Brasil - P/E of 12 with yield of 2.5%

Ambev - P/E of 6 with a 4% yield

 

there's a dozen or two more ADRs for Brazil as well.

 

Stocks in China are relatively well valued. Turkey is an incredibly low CAPE as well (I think it's around 8). Etc. etc. etc.

 

 

Obviously like anything value related, there's a reason it's cheap. But as a whole, relative to yields and CAPE ratios, EM as a whole below 20th percentile in value while the U.S. is closer to 90-95th. Didn't mean to hi-jack this thread, but EM and low-leverage natural resource companies are really the only two places I'm seeing any compelling value and the yield exists there.

 

 

 

 

[Jurgis]

Regarding EM debt, I've looked at EMB and EMLC and the drawdowns are high.  :-\

 

EMB is about 10% drawdown - maybe covered by yield, but you still end up at zero.

EMLC went 30% down and has not recovered - I think this is currency effect, but still.

 

Maybe it's possible to speculate that they are cheap now, but I would not be able to make that decision.

 

Anyone has input/insight?

 

 

To repeat, I'm looking at two areas: cash substitute that I could withdraw immediately at market crash (currently in ISTB) and just fixed income that has higher yield and may be "locked" (i.e. not sellable due to downdraft) during market downturn (currently a bit in BACPRL and PONDX).

 

EMB/EMLC are clearly not a match for the cash sub. I am not sure they are match for second either. I'd probably prefer SRLN (which I sold due to some concerns) vs EMB/EMLC. I might be totally wrong on this though.

 

I am not looking at equities for yield. Of course, you guys are free to discuss equities too. It's just not what I'm looking for.  8)

 

Thanks

[TwoCitiesCapital]

Regarding EM debt, I've looked at EMB and EMLC and the drawdowns are high.  :-\

 

EMB is about 10% drawdown - maybe covered by yield, but you still end up at zero.

EMLC went 30% down and has not recovered.

 

Maybe it's possible to speculate that they are cheap now, but I would not be able to make that decision.

 

Anyone has input/insight?

 

 

To repeat, I'm looking at two areas: cash substitute that I could withdraw immediately at market crash (currently in ISTB) and just fixed income that has higher yield and may be "locked" (i.e. not sellable due to downdraft) during market downturn (currently a bit in BACPRL and PONDX).

 

EMB/EMLC are clearly not a match for the cash sub. I am not sure they are match for second either. I'd probably prefer SRLN (which I sold due to some concerns) vs EMB/EMLC. I might be totally wrong on this though.

 

Thanks

 

Agreed that by themselves they aren't a substitute, but that's why I suggested the bar-belled approach. I'm not particularly familiar with the two tickers you have listed, but was thinking that a simple diversified approach of a % in t-bills as a cushion and the remaining % in EM equities/debt as the return seeking portion would get you close to what you need.

 

It's not hard to get yields exceeding long-term U.S. treasuries with a portfolio half in T-bills and half in EM equities/debt and you still have that 50% buffer in the event you need to sell.

[Jurgis]

Right, I understand what you are saying.

 

I still don't think EMLC/EMB are good for the risky-higher-yield part of fixed income barbell. And equities (even high yielding ones) for me are in yet another part of "barbell" (except now it becomes more like a 3D barbell).

 

Anyway, thanks for your thoughts.

[Wild]

I've always thought the concept of "need for yield" was particularly dumbfounding in the current investing landscape. If only because yield pertains to a metric of return. In my eyes with rates this low if one were aiming for some metric of return it would be more effective to invest in stocks. Bonds to me in this current marketplace make great investment choices for real conservative portfolios, but even ones held over longer durations suffer because if you have a long duration to maturity it means you may be foregoing potential returns in lieu of a more conservative portfolio (by the nature of having lots of time til target date).

 

So from that standpoint, the reason for investing in a bond isn't to maximize yield per se, but to gain a benefit of holding less volatile securities. By searching for one with a higher yield, you're immediately negating that strategy of "holding less volatile securities" since return goes up with risk.