Adding Color to the Medium Duration Income Portfolio

Expanding on our earlier announcement on the new Medium Duration Income Portfolio.

We know from history and logic that bonds and term preferred stocks are more stable in price as there is a ‘date certain’ for redemption or maturity–the longer the date in the future the  redemption/maturity date is the more volatile the share price will be as interest rates move.  This means that even if interest rates rise the share price reaction will be just a tiny fraction of the movement in a similar coupon issue of a perpetual preferred which has no state maturity and may well be outstanding for decades and decades.  If the price is way above $25 or way below $25 as the redemption/maturity date approaches the share price will move closer and closer to $25.

In the past we have composed portfolios of the above types of securities and they have performed very well.  They have paid a reasonably good income stream while maintaining relatively level share prices–this helps us sleep very well at night.  We currently maintain 2 portfolios similar to these on the website.  The longest running portfolio we have constructed in this manner can be found here and has returned about 6.5% annually.

Now it should be obvious that the investor will not ‘get rich’ owning a similar portfolio and that is not the point of the portfolio.  The point is a reasonable return with low volatility which allows a retired person to sleep well at night.

A key to the portfolio is that the general economy remain fairly strong–not in recession.  The issues in the model are NOT investment grade and thus you have to watch the issuer of these securities to make sure financials are NOT going ‘south’ on a sustained basis.  A weak quarter or two is generally not a large concern, but a steady 6 quarter slide would be a cause for concern.

A few words on the starting issues.

Gladstone Capital–a BDC (business development company) has generally performed well.  Being a BDC which is also a closed end fund they are required to have asset coverage of 200% or more which adds a level of safety.

Eagle Point Credit–a specialty finance company which owns a portfolio of CLO’s (collateralized loan obligations) which has performed very well in recent quarters.  While we are not fans of CLO’s and similar instruments ECC is a closed end fund and subject to the 200% asset coverage requirements.

RiverNorth Marketplace–is a non traded mutual fund which owns a portfolio of loans secured from peer-to-peer lending sites.  We are not huge fans of peer to peer lending as the credit risk seems to be higher from our personal experience.  Given the short maturity of the term preferreds we believe shares will perform just fine in spite of what we believe will be marginal performance of their loan portfolio.

To expand further on peer-to-peer sites (ie Prosper).  Originally borrowers would ‘apply’ for loans and ‘lenders’ (you and I) would bid on the loans.  Initially the credit quality was highly suspect  and we didn’t believe the sites were doing a very good screening job on the ‘borrowers’.  After poor performance the sites tightened credit screening and loan performance improved.  Then a few years ago ‘bulk buyers’ of loans came into the market place which changed how these sites operate.  Instead of bidding for loans the bulk buyers are allowed to short circuit the bidding process and instantly do the loan. This means (in our opinion) that the bulk buyers are allowed to buy the best loans–by best we mean the highest credit quality with extremely solid credit histories.  We have not checked RiverNorth portfolio in extreme detail, but we are guessing the quality of loans is better than what we have personally experienced.

Personally we had invested thousands of dollars into loans when Prosper initially launched the site.  Because of issues with their credit screening we experienced losses of 8% for the first couple of years.  After improvement our returns went higher and now are at 4.86% annually since inception.  This was more a trial of the site than a search for yield and we have now been reducing our holdings (as the loans mature we have withdrawn) and are down to around $500 now.

Arbor Realty Trust–a commercial mortgage REIT with good financial performance in the last couple of years.

Sotherly Hotels–a small lodging REIT that has had decent FFO (funds from operations) recently

We think investors in these term preferreds and baby bonds need to at a minimum pay attention to the quarterly earnings reports to ensure resources are adequate to fund dividends and interest payments–BUT if the economy softens subtantially investors have to use more intuitive feelings to determine whether to buy or sell these securities.



5 thoughts on “Adding Color to the Medium Duration Income Portfolio”

  1. Hi Tim-
    Thanks for all your insight over the years!
    Question- Do you have any concern over call risk with ABRN, GAINN and ECCA in the Short/Medium duration portfolio ?

    1. Hi Joe—I will be covering this in the very near future. Many of these issues are in or near their 1st early redemption date–this makes them near perfect to hold. The ‘threat of call’ keeps them above $25, but not too much above $25.00. Investors believe they may be called soon so if they fall below $25 they are bought. Investors also thinking they may be called won’t bid them much higher than $25 + accrued dividends/interest. GAINN and ECCA are not yet in their redemption periods and trade at a point where there is no monetary damage possible to a current holder in a call. ABRN is now callable, BUT Arbor has 3 preferred — all at coupons above the ABRN issue. 2 of these become callable in the next 3 months and the 3rd issue becomes callable in 12 months.

      So am I concerned–not much–but of course there is always a chance. But when the risk is maybe 20 cents a share versus the nice dividends/interest these are paying it is worth the small risk.

      Hope you stick around and best of luck


      1. Tim, Im a big lover of ABRN myself! Although I own different issues, I am a big believer in your thought process of past call issues with above market yields trapped near par from call risk (and term dated issues, too). I got my widows preferreds also like KYN-F, for example, but I also like to push the envelope on call risk such as OSBCP and ALLY-A….I had NSS and AHT-D in that camp also, but I think their call risk has decreased significantly the past few weeks.

  2. Hi Ann–glad you are here and hope we can add a little value on a timely fashion for income investors. Sometimes income investings isn’t all about making money–maybe just NOT losing money.

    Good luck

  3. I am so happy you have started this website. I have missed your insights into an area of investing I am still rather new to. I have been investing in stocks for over 30 years but just started fixed income in the past 2 years. I value your advice and follow your portfolios closely. Thank you for all you do. Ann

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