Tag Archives: income

Junk Bonds: Time To Start Accumulating – Yield Over 21%

Summary Overselling mostly done in the junk bond space. I am buying for my retirement portfolio: CEFL – over 21% yield. Components of CEFL are trading at heavy discounts, and the security is on the rebound. CEFL: An opportunistic buy. Following my latest article on my high-yield “Model Retirement Portfolio” (6% Dividend Target) published Monday (December 14) on Seeking Alpha, recommending dividend investors to start buying the UBS ETRACS Wells Fargo Business Development Company ETN (NYSEARCA: BDCS ), the shares of the ETN have rallied around 3%. I believe there is much more upside to come, as the sector is still oversold with no real merit. If you have not started to buy, it is not too late. For those who have opted to buy the leveraged version, the UBS ETRACS 2X Leveraged Long Wells Fargo Business Development Company ETN (NYSEARCA: BDCL ), the shares closed over 6% up since Monday. I promised in my Monday article to give an update on the best time to start accumulating on junk bonds. Well, the time has come! I will provide guidance on the best approach. Update on the Junk market space The sector recently experienced heavy losses and a meltdown , leading to heavy redemptions by investors. This was sparked by rock-bottom levels of risk tolerance, persistent downside risk to commodity prices, and turmoil in emerging markets. However, recent comments from high profile investment banks have calmed down the markets: UBS (NYSE: UBS ) reported last Monday: Junk bonds sell off, oil drop worries are overdone. The Chief Investment Officer at Guggenheim Partners stated: There is a “buy” signal for junk bonds. A Goldman analyst stated that investors are being too pessimistic . BlackRock’s Senior Director stated on Monday that junk bonds won’t spark a new crisis. It will be contained. Tracking this sector, the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA: HYG ) and the SPDR Barclays Capital High Yield Bond ETF (NYSEARCA: JNK ) both ended the week with returns (before dividends) of 1.66% and -0.18%, respectively, during the last 5 trading sessions. This is despite heavy losses for the week sustained in all the major indexes. So it looks like we are close to a bottom. Best way to enter the Junk Bond Space To be prudent, I am not investing directly into the junk market ETFs. I am investing with a much more balanced approach using the UBS ETRACS Monthly Pay 2xLeveraged Closed-End Fund ETN (NYSEARCA: CEFL ), a leveraged Exchange Traded Note issued by UBS with a stated yield of over 26%. What exactly is CEFL? CEFL is a fund of “closed-end funds” (basically a fund of funds) issued by UBS. It comes in the form of an exchange-traded note (ETN) linked to the monthly compounded 2x leveraged performance of the ISE High Income index. Its objective is to capture the top 30 closed-end funds as determined by a ranking scheme, allowing investors to take advantage of both event-driven news and long-term trends of the U.S. closed-end fund marketplace. The note is leveraged, so it pays approximately twice the yield of the related index, which comes with a stated yield of 21.78% ( UBS ). The dividend is paid monthly via a variable monthly coupon. CEFL’s top ten components (making up 45% of total holdings) are depicted in the following table, which includes the weight of the security and the discount to net asset value (NAV) and return of capital for 2015. (click to enlarge) Advantages of Investing in CEFL Now: CEFL is not a pure junk bond play. It is a very diversified product which includes, among others, preferred shares, mortgage backed securities, corporate bonds, junk bonds, emerging market bonds, foreign government bonds, investment grade corporate bonds, high yield corporate bonds, and even certain stocks. It offers one of the most diversified ways to invest in the high-yield bond space, as it is basically a “fund of funds”. The security has been selling off since the beginning of the year, both from worries of higher interest rates and from the junk bond crisis. The shares have lost, after dividends, over 17% of their value. Signs of life and rallying the past week: CEFL is up 5.8% during the last 5 trading sessions. This is despite the heavy losses sustained in all the indexes. The S&P (NYSEARCA: SPY ) was down about 1.2%, while the Dow Jones Index (NYSEARCA: DIA ) was down 1.4%. It is a good time to catch them on the way up. CEFL components are still trading at a heavy discount to net asset value. As seen on the table above, the average discount of its 10 top components is 13.1%. So this security is on fire sale. CEFL provides exposure to emerging markets through its bond portfolio. With certain analysts predicting that emerging markets will start recovering in 2016 and 2017, along with the prices of commodities, CEFL will benefit from such a recovery. Several investment bankers, including Goldman, Guggenheim, UBS, and BlackRock, have just started being optimistic. Now that the fears of high rate increase by the Fed have started to dissipate (only 0.25% hike and prudent approach to future hikes), I expect the security to do well in the short and medium term. Other Important Information on CEFL: Not all the stated 21.78% yield is actual dividend. Part of it is a return of capital as some of these funds had to return part of the investment to their shareholders in order to maintain yield. If we have a look at the table above, the average “return of capital” for the 10 largest holdings is 15.3% for the year 2015 (to-date). If we assume the same percentage for all the securities, that will give CEFL an effective yield of 18.4%. CEFL’s dividend is also variable. The security of CEFL is twice leveraged. So any price movement in the underlying securities will have a double effect. Expect volatility, but do not worry much, the fundamentals are good. It may be wise to spread small purchases during a period of one week. Try to average down during down days. Conservative Diversification Please note that I use conservative diversification to protect my “high dividend portfolio”. I have started buying CEFL but will only allocate around 3% of my total portfolio to the security, especially due to the leverage effect. I advise investors to also take a prudent approach. For this investment, I am happy to get a dividend of over 20%, which means in 5 years, I should have all my capital back and the rest is pure earnings generating additional income. Get alerts for “My Model High-Yield Retirement Portfolio” (6% Dividend Target) I am currently sharing future opportunistic additions to my “Model Retirement Portfolio” (6% Dividend Target), for which I often use ETFs and CEFs to protect my “egg nest” against volatility and against the risk of investing in a single security. Furthermore, my conservative strategy includes scrutinizing and generally avoiding excessively high dividend securities, which may lead to disproportionate risk taking and heavy losses. My target is to have a conservative and well-balanced high-yielding 6% dividend portfolio to generate long lasting income and protect against inflation. Please follow me if you are looking for dividend safety, diversification, and sound investment ideas.

Terraform Power’s Recent Moves Support Dividend Growth Of At Least 15% In 2016

Summary Terraform Power closed the first part of their planned transaction with Invenergy, 832MW of net wind power plants, increasing their current portfolio from 1.9GW to 2.8GW. I found it interesting that the company ended up changing the financing package for this transaction, which is expected to deliver unlevered CAFD of $139mil in 2016. Terraform also recently updated their purchase agreement with SunEdison for the producing assets of SunEdison’s deal to buy Vivint Solar. The updated deal projects that Terraform will pay $799mil to purchase 470MW of producing assets. These assets should produce annual CAFD of around $73-75mil. Both transactions support an increased dividend in 2016. The actual amount will depend on the timing of the transactions, but I expect 2016 exit rate of at least $1.60/share. Terraform Power (NASDAQ: TERP ) has had a pretty busy last couple of weeks. The company completed a large part of their planned transaction with Invenergy on Wednesday, buying 832MW of wind assets. This comes on the heels of the announcement last week of a renegotiation of the terms of SunEdison’s (NYSE: SUNE ) purchase of Vivint Solar (NYSE: VSLR ). The updates have removed many of the concerns investors have had with TERP, and the stock has responded in kind, as it has almost doubled from its late November lows. As I explain below, these transaction also support a continued dividend increase in 2016. TERP data by YCharts TERP came out with solid 3rd Quarter results in early November, but management’s unwillingness to confirm their previously estimated 2016 dividend increase to $1.75, and liquidity concerns at sponsor SUNE, led to the stock plunging over the next two weeks $6.73. At that point, the current yield was 20%. The market finally came to its senses when David Tepper announced a large stake and sent an open letter to management. Invenergy Transaction: Sources/Uses of Fund Changed One of the interesting takeaways from TERP’s announcement of the Invenergy transaction is the fact that they changed the way they ended up financing it. Back in July when the deal was made, the plan (see page 17) was to place half the MW into TERP immediately, and hold the other half in a SUNE warehouse. From August thru the 3Q earnings call in November, the plan (see page 18) was to only drop down 265MW and place the rest in a structured warehouse. Now it seems that management has decided to place all of the projects directly into TERP immediately. Sources of Cash Uses of Cash Non-Recourse Project Debt assumed or incurred with respect to transaction $801m 832MW of Wind Assets located in US and Canada $1,962m Pro-rata portion of $500mil new non-recourse term loan $417m Cash on Hand (incld proceeds from TERP $300mil senior note offering in July 2015) $744m $1,962m $1,962m The press release notes that, “once all projects are operational, the first year adjusted EBITDA (before minority ownership) is expected to be $147 million, and unlevered CAFD (before all project and HoldCo debt payments) is expected to be $139 million.” Unfortunately, this doesn’t clarify how much we should expect the project and HoldCo debt payments to be, so it’s tough to predict how much of the unlevered CAFD will actually be available for dividend payments. My best estimate is to use the initially projected cash on cash yield of 8.4%, which equates to about $62mil (8.4% x $744mil cash on hand). We’ll have to wait for TERPs 4Q results for more details. The new $500mil term loan charges LIBOR + 5.5%, with a 1% LIBOR floor, meaning that TERP is currently paying 6.5%. It matures in 2019 and can be prepaid anytime, so it’s very likely that TERP will refinance this as soon as they can organize something with better terms. Vivint Transaction Terms Improve Last week TERP and SUNE announced that they had improved the terms of the Vivint transaction. TERP was able to reduce their initial purchase commitment from $922mil down to $799mil, by only paying for completed installations, and paying a reduced fee of $1.70/MW. The final total will depend on the actual number of producing MW transferred when the Vivint deal closes sometime during Q1 2016. In their Q2 earnings presentation, management noted that they expected the 523MW to generate average unlevered CAFD of $81 annually, so I project that the 470MW delivered at close will generate $70-75mil annualized unlevered CAFD. Considering the fact that TERP used substantially all of their cash on hand at the end of Q3 to fund the Invenergy transaction, it’s likely that they will be drawing on their revolver for much of the $799mil. The revolver’s rates are currently under 3%, so the annual interest would be about $24mil. Thus, I expect final CAFD to be about $50mil. 2016 Updated CAFD Projection Based on their 3Q presentation, TERP expected to generate CAFD of about $208mil before taking into account the Invenergy and Vivint transactions. If we assume that the Vivint transaction closes by the end of Q1, we should see annualized CAFD at the following levels next year: Quarter End Q1 Q2 Q3 Q4 Annualized CAFD $270m $320m $320m $320m CAFD distributed (85%) $230m $272m $272m $272m Per Share Quarterly Distribution $.35 $.40 $.40 $.40 The quarterly distribution estimates include the effect of SUNEs IDRs. I don’t expect TERP to actually increase the dividend to $.40 for Q2, even though it seems that operations would allow this. Rather, it’s likely that they will prefer to show steady quarterly increases up to $.40/share in Q4. This confirms my view that these transactions will cause TERP to increase their dividend by at least 15% over the next year.

Time To Throw Out The Rising-Rate Playbook?

Summary Relying on “tried-and-true” rising-rate playbook strategies in today’s markets may not be helpful because we’ve never been in this exact economic environment before. The “typical” conditions that have accompanied tightening cycles during the past 35 have mostly run their course in the present cycle, which is more than six years old. Unprecedented conditions call for active management because rules-based approaches that rely heavily on historical playbooks often break down at inflection points. Today’s markets are in uncharted economic territory, where ‘go-to’ strategies require prudent skepticism By Clint Harris, Senior Client Portfolio Manager We’ve seen daily references to what has worked – or hasn’t worked – when interest rates have risen in the past. Strategists, asset managers and pundits have dusted off numerous “tried-and-true” historical playbooks for investing in a rising-rate environment. But here’s the problem with applying those lessons to today’s markets: We’ve never been in this exact economic environment before, so relying too heavily on what’s worked in the past may not be particularly helpful. What makes today’s environment unique? In my view, the current torrent of rising-rate analyses should be taken with healthy dose of skepticism. Why? Here are three reasons. First, the “typical” conditions that have accompanied tightening cycles during the past 35 years include rebounding margins and improving credit conditions and sales growth. But these conditions have mostly run their course in the present bull market cycle, which began in March 2009. Today, margins are plateauing (Figure 1), credit conditions are worsening (Figure 2), and sales revisions are showing declines in growth. Figure 1 Source: FactSet Research Systems. Past performance is not a guarantee of future results. What happens when monetary policy tightens in the midst of these conditions? We don’t know because we’ve never seen it happen. It’s unusual for the Federal Reserve (Fed) to begin monetary tightening so late in the profit cycle. The Fed has rarely, if ever, started to raise rates when sales growth is disappointing, delinquency rates for commercial and industrial (C&I) loans are worsening (Figure 2), corporate margins are narrowing, and other major central banks are loosening monetary policy. Figure 2 Source: FactSet Research Systems. Past performance is not a guarantee of future results. Second, the federal funds target rate, currently between zero and 0.25%, 1 hasn’t seen these levels since the 1940s (Figure 3). The 10-year US Treasury bill, at 2.32% for the week ending Nov. 13, hasn’t been this low in 60 years. 1 We have simply not seen a tightening cycle from these levels in modern times. Figure 3 Source: US Treasury. Past performance is not a guarantee of future results. Third, many asset classifications in use today – for example, value stocks, growth stocks, core plus bond strategies, emerging market debt, master limited partnerships (MLP), floating rate securities and convertibles – either didn’t exist or didn’t have widely available proxies in the 1920s and 1930s. As a result, no one has been able to write a playbook that goes back far enough in history to be applicable to today’s environment. Even if we could, the economy is so different today that the interpretation may be misused. Where do we go from here? Unprecedented conditions call for active management. Why? Rules-based approaches that rely heavily on historical playbooks often break down at inflection points. This is particularly important today as I believe we face the most expected tightening cycle in history. Active management uses sound fundamental research to anticipate potential changes in conditions to position client assets accordingly. Our Invesco Dividend Value team has often remarked that results for our clients are made or broken at inflection points. It’s important to exercise a healthy degree of skepticism and a willingness to go against consensus when supported by bottom-up analysis. This is particularly important today as everyone seems to be using the same rising-rate playbook. Our team has successfully navigated numerous economic environments by maintaining a full market cycle perspective. We believe this experience becomes even more important as investors, who are less focused on the signs of a mature profit cycle, seek a revised rising-rate playbook for today’s environment. Learn more about Invesco Diversified Dividend Fund and Invesco Diversified Income Fund . Sources US Federal Reserve System, Nov. 16, 2015 Important information Profit margin measures the profitability of a company by dividing net income by revenues. A master limited partnership is a publicly traded limited partnership in which the limited partner provides capital and receives periodic income distributions from the MLP’s cash flow and the general partner manages the MLP’s affairs and receives compensation linked to its performance. Floating rates are interest rates that are allowed to move up and down with the rest of the market or with an index. The federal funds target rate is the interest rate at which banks and other depository institutions lend money to each other, usually on an overnight basis. An inflection point is an event that results in a significant positive or negative change in the progress of a company, industry, sector, economy or geopolitical situation. Credit conditions denote the availability of loans, or credit. About risk A value style of investing is subject to the risk that the valuations never improve or that the returns will trail other styles of investing or the overall stock markets. The Fund is subject to certain other risks. Please see the current prospectus for more information regarding the risks associated with an investment in the Fund. Before investing, carefully read the prospectus and/or summary prospectus and carefully consider the investment objectives, risks, charges and expenses. For this and more complete information about the products, visit invesco.com/fundprospectus for a prospectus/summary prospectus. The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals. NOT FDIC INSURED MAY LOSE VALUE NO BANK GUARANTEE All data provided by Invesco unless otherwise noted. Invesco Distributors, Inc. is the US distributor for Invesco Ltd.’s retail products and collective trust funds. Invesco Advisers, Inc. and other affiliated investment advisers mentioned provide investment advisory services and do not sell securities. Invesco Unit Investment Trusts are distributed by the sponsor, Invesco Capital Markets, Inc., and broker-dealers including Invesco Distributors, Inc. PowerShares® is a registered trademark of Invesco PowerShares Capital Management LLC (Invesco PowerShares). Each entity is an indirect, wholly owned subsidiary of Invesco Ltd. ©2015 Invesco Ltd. All rights reserved. Time to throw out the rising-rate playbook? by Invesco Blog