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Since August when I first proposed the 7.5% CEF bond portfolio, share prices have continued to slide down to where an equal purchase of each of the funds today would yield around 8.7%. So the question is, need you worry?
Well let's review all of these issues. The reason we buy bonds is to help counteract the action in the stock market. What we want are stable, consistent dividend payers. The fact that the share prices either climb or drop is secondary to the yield we hoped to achieve from the money we invested in them. Investing in these funds is for the long term, so what these funds do in any one year, should not discourage us in any way.
Of the ten funds selected, they are grouped in two categories. Five are a proven set of fixed-rate bond funds that hold primarily government issues from the U.S. and around the world. These are AWF, BNA, KMM, RCS and TEI. The other five are floating-rate funds which hold floating and adjustable-rate government and corporate bonds. Both groups are currently selling at an average of a 10% discount to NAV. These are BGT, EFL, EFT, PHD, and PPR.
The first group has an average yield of 7.9% and the second 9.5%. Together they come to 8.7%. Bonds form a solid foundation for a portfolio but of course are not an entire investment structure. Therefore, stocks, real estate, insurance, IRAs, etc. form a well rounded investment portfolio.
These funds together provide exposure to the full range of the world's debt markets. If we cherry pick among these, we take a much greater risk. Holding them all puts the best debt managers in the world on your payroll. They have proven their ability to survive in the most difficult markets. Many of these funds have been hit hard as investors began to worry about defaults in the high-yield or junk bond market as the possible next stage of the expanding global credit crunch. But actual defaults are near all-time lows. Also, these funds are extremely diversified with ING Prime Rate as an example (PPR), owning more than 500 securities. And since these are senior debt holdings, we are the first to get paid on all assets if they run into any trouble.
So let's go through these one by one. Starting with AWF, the fund invests primarily in U.S. dollar-denominated bonds and also other denominations as well. BNA focuses on North American issues with improving values and higher income. KMM adds more corporate bonds as well as some strategic government issues in the U.S. and abroad. RCS has a stable of agency bonds, investing in the best of the international and domestic bond markets and TEI's focus is on government bonds in emerging economies. This represents the core group of our closed-end bond funds.
Next comes our group of funds focused solely on floating rate bonds in the U.S. and abroad. Typically these bonds have a seasonal selloff in the spring, can get hit with inflation concerns and also suffer when investors become more enthusiastic for growth and temporarily move away from bonds. But often they come back in the summer and fall. This year however, with interest rates falling, the dollar declining, the housing market in a downslide, oil in the stratosphere (and probably going higher in the future) and Bugs Bunny nowhere to be found, these funds that typically adjust upward with higher rates while not sinking when rates ease up, have performed just the opposite of what one would expect. They've come down as rates have eased.
So let's take a closer look. BGT is invested the U.S. and abroad, primarily in corporates but also in government agency floating-rate debt as well. The credit rating is lower grade, but still of quality, with most issues from the major petroleum companies around the world. They're not going out of business. EFL is focused on foreign government floating-rate bonds with higher yields and improving bond prices, very similar to TEI's fixed-rate focus. EFT's focus is on the intermediate-to-longer term government bond market. PHD is a corporate focused fund, with most issues maintaining a B or better credit rating. This includes many high cash flow industries that can deal with the floating nature of their debt. Lastly, PPR is focused on U.S. corporate debt. A more detailed description of each of these funds can be found if you look at the portfolio itself that I constructed back in July or by going to ETF connect.
These funds may all continue to move lower but with an average of a 10% discount, we're only paying $.90 for each $1.00 worth of bonds. And we're collecting the monthly or quarterly dividends along the way. The pendulum swings, often from one extreme to the other. Whether we have reached a low point or not, only time will tell. But if you put a little bit of money into this basket of funds, your dividend yield will certainly be attractive. If the share prices continue to drop, then you can always add a little more and improve your overall yield further.
I personally purchased $5,000 of each as you know when the overall yield was 8%. Am I disappointed, sure, because I would have liked to see the share prices remain stable or even move up. But am I discouraged - no. This $50,000 was placed in these funds to generate about $4,000 in dividends and since it's in my ROTH account, I don't have to worry about the tax implications. So I'll just collect the dividends year in and year out.
This portfolio won't make you rich, but you'll have a great yield. And the funds will still be around.
That's all for now. have a great day tomorrow.
Pete Lipke |