One of the factors in my estimation that will be a huge part of 2020 is the Heaven that has been created by the central banks of the world for Borrowers. We are still tracking approximately $14 trillion in negatively yielding debt and while this number is not currently at its high mark of $17 trillion, it is not that far off the record. Regardless of that, though, our 10 year Treasury is at 1.585%, while our two year is at 1.428%, and our 6 month Bill is at 1.54%.
In the current year I expect a massive amount of re-financings, tender offers, calls, and bank debt re-financing as yields are held steady, or forced down, by the central banks. This will impact earnings positively for many companies, as their costs of borrowing declines. It will also be a positive for many governments, as their costs of funding is likely to decline from present levels.
Then the Bloomberg Index for Treasuries yields 1.565% which is up 2.15% for the year to date. What is even more interesting is America’s Investment Grade Corporate Index which yields 2.589% and is up 2.51%, so far this year, and is only back of the Treasury Index by 102 basis points, as the compression continues. In comparison is the Bloomberg High Yield Index, which is only up 1.11 bps and stands at 5.107% currently.
Safety is still a concern, as indicated by the performance of these Indexes, though the valuation of “Credit Risk” is at minimal levels, in my viewpoint. This indicates, to me, the “Hunt for Yield” is similar to the “Hunt for Red October” as money chases anything and everything that has any yield left. For those that need income, such as pension funds, insurance companies, seniors, retirees and the like, this is a very difficult time. The “Appreciation Basket” did spectacularly last year and made up for some of the yield declines. I do not expect a repeat performance. Back-to-back performances of this kind are rare birds and yield buyers are playing a game of “chicken” at our current yield levels.
“The hard part about playing chicken is knowing when to flinch.”
– The Hunt for Red October
The problem is what to do about all of this and I, as previously stated, have an answer. The least appreciated, and most undervalued, part of the markets, in my estimation, is still the “Closed-End Funds.” Here, if you know what you are doing, and it is complicated, you can still find double digit yields and funds that write monthly checks.
Sure, you can buy high dividend stocks or even higher yield Exchange Traded Funds (ETFs), but to achieve double digit returns you are, for the most part, still relying upon “appreciation.” Further, almost none of the ETFs, or higher dividend stocks, have monthly payments which allows for several distinct opportunities. First, monthly checks means that the “compounding of interest” comes into play if you re-invest part, or all, of the money each month. Second, it means that each and every month you have the opportunity to pick what looks the most attractive for re-investment, as the world waddles one way and another. Third, it means that money is available each month, minus some debacle, and regardless of the over all markets moves, to cover your expenses.
In this double digit yield closed-end funds bond space you can find MLP funds, a mostly gold fund, bond funds, loan funds, high yield funds, pipeline funds et al, so there is a great diversity of choices. Sure, dividends can be cut but they can also be cut in the single stocks with a higher yield. Yes, most of the closed-end funds have leverage but then so do most companies, as they have bonds, and borrow money from the banks. I do point out that the closed-end funds are regulated and can only have a maximum of 50% leverage, though virtually all of them, are significantly under that number.
I also keep my eye on liquidity, the number of shares that trade each day, and that is another of my considerations. Then you have to watch the “Net Asset Value” (NAV) and the discount or premium that you might be paying. I am OK with a slight premium, if the yield is attractive enough, but anything over “slight” is dismissive for me, as I am not interested in over-paying for the assets of the fund. Then you must drill down, and I mean do your homework, on what each fund actually owns, to determine if you are comfortable with their holdings.
Next, I do a performance review and look at their 1, 3 and 5 year’s performance. I also consider the indicated yield, as opposed to the 12 month yield, to make my determinations. Remember, that while these funds can certainly cut their dividends that they can also raise them, and some have a history of making an end of year distribution.
Closed-end funds are complicated, it is tough to figure them out, but they are well worth the effort, in my determination. They are certainly not for everyone but for those that want monthly income, and higher yields, then they are a sector of the market that you might wish to explore. You must also check on the managers of these funds, as some are clearly better than others.
One of the significant differences between the ETFs and the closed-end funds is the “tout” in the marketplace. An ETF manager makes more money if more money is invested in the fund. This is not the case in closed-end funds as more money will move the price, but not change the amount that the manager makes. This, in my opinion, is one reason why closed-end funds are often overlooked as investment opportunities.
“If a window of opportunity appears, don’t pull down the shade.”
– Tom Peters
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.