Income may not have the sizzle of selecting stocks, but many experts recommend maintaining a balance between equities and fixed-income. Several income specialists, and contributors to MoneyShow.com, offer their top ideas among some lesser-known income vehicles, including municipal bonds, convertibles, preferreds, and floating rate securities.
Marvin Appel, Signalert’s Systems & Forecasts
I believe that corporate high yield bonds represent the best bond opportunity in 2020. I particularly favor short-term corporate high yield bonds, as represented by the SPDR Short-Term High Yield Bond ETF (SJNK), which yields 5.1%.
Investment-grade municipal bonds are relatively overvalued compared to investment-grade taxable bonds. In contrast, high yield municipal bond funds are attractive in the sense of being the best house in a bad low-yield neighborhood. Even during recession scares such as 2011 or 2016, these funds held up.
On the other hand, when interest rates jumped as in 2013 or late 2016, these funds fell alongside their more creditworthy investment-grade peers. Note that in 2008, the perfect storm of liquidity problems and recession caused major losses in high yield muni bond funds. But with the bond markets indicating a potentially sluggish but stable economy in 2020, high yield muni funds should perform relatively well compared to other types of municipal bonds.
One fund I recommend is the Nuveen Short-Duration High Yield Municipal Bond Fund (NVHIX). Because of its duration of 3.8 years (not really a short-term bond fund but less that of other high yield muni bond funds), NVHIX affords you some protection in the unexpected event of a jump in interest rates. The SEC yield of NVHIX is 2.8%, which is free from federal but not most state income taxes.
I have no great feel for whether interest rates are going to move up in a pronounced way anytime soon, but I am of the view that we may well have seen the lows for interest rates and bond yields for the current cycle. Under this assumption, it may warrant buying into a depressed fund of assets where the current payout will rise if interest rates also climb.
This is where I believe owning a position in the BlackRock Floating Rate Income Strategies Fund (FRA) makes sense to me at a time when the fund is trading at a 12.00% discount to Net Asset Value (NAV) and pays out a current yield of 7.45% on a monthly basis. At present, there is $536 million in assets within the fund primarily invested in what are called “senior loans” that are corporate obligations.
The fund seeks a high current income and preservation of capital investing in a diversified and leveraged portfolio consisting primarily of floating rate debt securities and instruments. At present, the fund employs 27.66% leverage to achieve the 7.45% current yield for the portfolio that owns 426 positions of which 87% is based in the United States.
The managers at the fund raised the monthly payout in October to $0.0788 per share and the income stream bears no return of capital. Plus, 100% of the dividend payout is earned interest. Depending on the rate of inflation and growth expectations for the economy, the shares could make their way back up to $15-$16 in an up-rate environment. That, coupled with a 7.45% yield, would provide a total return of 25.5%.
Todd Shaver, Bull Market Report
There are two things that make munis funds a terrific investment at the moment. First, muni bonds have their own yield curve, so when the traditional yield curve flattens, it makes munis that much more attractive. Second, munis provide tax-free dividends, which make them especially attractive to investors who are in high tax brackets.
Invesco Municipal Trust (VKQ) is a well-managed muni fund. Invesco is one of the premium brands in bond investment, so investors feel safe with the company. Additionally, the fund offers a 4.6% annual yield — tax free. All of this makes Invesco a strong defensive play as the traditional bond market takes a shellacking from the flat yield curve.
As continued anxiety in the bond sector places downward pressure on the market, expect a continued flight to munis from investors looking for a tax efficient means of dividend generation.
Like its counterpart from Invesco, Nuveen AMT-Free Municipal Credit Income Fund (NVG) is another premium brand name, which implies safety for investors as they rotate out of traditional bonds and into the tax-beneficial munis. It also offers a healthy 4.7% tax free annual yield.
The fund invests up to 55% of its portfolio in below-grade investments (rated BBB or below). When selected properly, these investments provide outsized returns. And the management team here has an excellent track record. They are diversified across the country (major holdings are in Illinois, California, Texas and Ohio), and across industries as well.
Both Invesco and Nuveen are great companies, and both worth investing in (remember to spread your eggs across multiple baskets). Muni funds provide an extra layer of security at the moment, and with the bond market under continued pressure, expect the sector to outperform in 2020 as well.
Michael Foster, Contrarian Outlook
If you’re not familiar with preferreds, they’re a hybrid of bonds and stocks. They can trade on an exchange, just like any common stock, but they trade around a par value and dole out a set regular payment, like a bond. Financial companies are the main issuers of preferreds.
Their main hook? Large dividends. With the 6.6%-yielding First Trust Intermediate Duration Preferred & Income Fund (FPF) you’ll get access to a portfolio of preferred shares and bonds that consistently crushes the index.
Preferreds are less protected from a fall in corporate profits than corporate bonds, which means that their prices can experience significant swings in times of market fear. First Trust Intermediate Duration Preferred & Income manages that risk by limiting duration to the shorter end of the intermediate range: the portfolio’s current duration is 3.55 years.
Furthermore, its portfolio volatility has been limited: the variance (0.56) in its NAV is low relative to similar funds, which means that its NAV doesn’t crash so hard that leverage is a serious risk.
Total fees (including interest expenses) come to 2.49% for the fund, which is just a bit below the 2.68% average for all preferred-stock closed-end funds. While this sounds very high, note that it’s taken out of the portfolio before returns and dividends are calculated. Thanks to this fund’s conservative and savvy investment style, it has crushed the index, and its managers have more than earned their keep. And that makes this a keeper.
George Putnam, The Turnaround Letter
Convertible bonds, which have been ignored by investors and Wall Street for years, may be worth a fresh look. A convertible bond is an unusual security in that it carries a fixed coupon and matures at par like a bond, but can also be converted into common stock.
Convertible bond investors get the downside protection that a bond offers, yet also participate in the upside should the common stock appreciate meaningfully.
A few caveats: convertible bonds are often “junior” to straight bonds, meaning they have lower priority claims, and so in a bankruptcy convertible bondholders may not receive much recovery (although they would come ahead of stockholders). Also, most convertible bonds are usually callable by the company which could limit their upside potential.
Listed below are three interesting convertible bonds with relatively high yields that also trade reasonably close to their conversion value.
Blackstone Mortgage Trust 4.75% due 2023
Blackstone is a real estate investment trust that provides secured senior loans to high quality office buildings, hotels and other properties in major gateway cities.
Conservative and well-managed by the eponymous and highly regarded private equity firm, the Blackstone convertibles offer investors the ability to participate in the stock while receiving a generous coupon. Investors may also want to look into the underlying stock as an investment in its own right.
Eagle Bulk Shipping 5.0% due 2024
U.S.-based Eagle Shipping is one of the world’s largest owner/operators of drybulk commodity cargo ships. The 5% bond was recently issued in July to help finance vessel acquisitions.
Industry conditions have been weak, but the company could be well-positioned for new emissions restrictions that go into effect next year. Notably, highly-regarded private equity firm Oaktree Capital owns 38.5% of the common stock.
U.S. Steel 5.0% due 2026
U.S. Steel is struggling with weak steel prices due to slowing demand in China, relentless capacity increases in the United States and the demand-reducing effects of the General Motors labor strike.
However, any recovery in prices would boost the profits of the high fixed-cost U.S. Steel operations. The company has considerable debt, and so the risks are elevated, but the 5% coupon helps buffer the volatility while offering participation in any sharp increases in the share price.
Mike Cintolo, Cabot Growth Investor
Fixed-to-floating preferred stocks are gaining in popularity recently. Like ordinary preferred stocks, they have no maturity, but their special floating rate feature protects them from future rises in interest rates.
Energy Transfer Partners Series E Fixed-to-Floating Preferred Shares (ETP-E) hit the market in April 2019; it is a fixed-to-floating issue, paying a solid 7.60% annually through May 2024, and then paying 5.16% plus three-month LIBOR (trading around 1.9%).
Combine that with the fact that it’s not callable for four and a half years, and investors are likely to earn a solid return here from the dividends, while ETP-E should remain relatively resilient even in the event interest rates head higher down the road.
Energy Transfer Partners is a giant master limited partnership, with assets totaling $91 billion that are spread all around the country and have a presence in most of the country’s major basins, including the Permian, Bakken, Marcellus, Eagle Ford and more.
Annaly Capital Series I Fixed-to-Floating Preferred Shares (NLY-I) doesn’t have a maturity date — but it does have a floating feature that should protect the preferred from falling much if interest rates rise. It will pay out at a 6.75% rate no matter what through June 2024, but after that, the preferred’s payment will be 4.99% plus three-month LIBOR
Annaly Capital is the big dog in the mortgage rate sector ($129 billion in assets), and its various fixed-to-floating preferred stocks have a ton of coverage, which is why we think it’s a good investment.
Given the cushion, Annaly Capital would basically have to blow up for the preferred investor not to get paid, and given the company’s size and solid history (it’s been public since 1997 and has navigated many market environments well) that is extraordinarily unlikely.