Working with Bonds, CEFs, REITs, MLPs, and Preferreds
by Steve SelengutMr. Selengut is a private investor and a contributing editor to LIFE&Health Advisor. He is the author of the book ‘The Brainwashing of the American Investor: The book that Wall Street does not want you to read.’ He can be reached at firstname.lastname@example.org
The larger the portfolio, the more likely it is that you will be able to buy round lots of a diversified group of bonds, preferred stocks, etc. But regardless of size, individual income securities have liquidity problems, higher risk levels, and lower yields spaced out over inconvenient time periods.
Of the traditional types listed above, only preferred stock holdings are easily added to during upward interest rate movements, and cheap to take profits on when rates fall. The downside on all of these is their callability, in best-yield-first order. Wall Street loves these securities because they command the highest possible trading costs — costs that need not be disclosed to the consumer, particularly at issue.
Unit trusts are traditional securities set to music, a tune that generally assures the investor of a higher yield than is possible through personal portfolio creation. There are several additional advantages: instant diversification, quality, and monthly cash flow that may include principal (better in rising rate markets, ya follow?), and insulation from year-end swap scams.
Unfortunately, the unit trusts are not managed, so there are few capital gains distributions to smile about, and once all of the securities are redeemed, the party is over. Trading opportunities, the very heart and soul of successful portfolio management, are practically non-existent.
Don’t let leverage spook you
What if you could own common stock in investment companies that manage the traditional income securities and other recognized income producers like real estate, energy production, mortgages, etc.? Closed end funds (CEFs), REITs, and royalty trusts demand your attention — and don’t let the idea of “leverage” spook you.
AAA corporate bonds, and utility preferred stocks are “leverage”. The sacred 30-year treasury bond is “leverage”. Most corporations, all governments (and most private citizens) use leverage. Without leverage, most people would be commuting to work on bicycles.
Every CEF can be researched as part of your selection process to determine how much leverage is involved, and the benefits — you’re not going to be happy when you realize what you’ve been talked out of.
CEFs, and the other investment company securities mentioned, are managed by professionals who are not taking their direction from the IRA & 401(k) mob. They provide you the opportunity to have a properly structured portfolio with a significantly higher yield, even after the management fees that are inside.
Certainly, a REIT or royalty trust is more risky than a CEF comprised of preferred stocks or corporate bonds, but here you have a way to participate in the widest variety of fixed and variable income alternatives in a much more manageable form. When prices rise, profit taking is routine in a liquid market; when prices fall, you can add to your position, increasing your yield and reducing your cost basis at the same time.
Now don’t start to salivate about the prospect of throwing all your money into real estate and/or gas and oil pipelines. Diversify properly as you would with any other investments, and make sure that your living expenses (actual or projected) are taken care of by the less risky CEFs in the portfolio. In bond CEFs, you can get unleveraged portfolios, and state specific municipal portfolios, etc, plus monthly income (frequently augmented by capital gains distributions) at a level that is most often significantly better than your broker can obtain for you. I told you that you’d be angry!
Another feature of investment company shares (and please stay away from gimmicky, passively managed, or indexed types) is somewhat surprising and difficult to explain. The price you pay for the shares frequently represents a discount from the market value of the securities contained in the managed portfolio. So instead of buying a diversified group of illiquid individual securities at a premium, you are reaping the benefit of a portfolio of (quite possibly) the same securities at a discount.
Additionally, and unlike regular mutual funds that can issue as many shares as they like without your approval, CEFs will give you the first shot at any additional shares they intend to distribute to investors.
Stop, put down the phone. Move into these securities calmly, without taking unnecessary losses on good quality holdings, and never buy a new issue. I meant to say: absolutely never buy a new issue, for all of the usual reasons.
As with individual securities, there are reasons for unusually high or low yields, like too much risk or poor management. No matter how well managed a junk bond portfolio is, it’s still just junk. So do a little research and spread your dollars around the many management companies that are out there.
If your adviser tells you that all of this is risky, ill-advised foolishness — well, that’s Wall Street for you, and the baby needs shoes.