I’m moving into the seventh category of Your Core Portfolio today, in which I’ll examine income securities.
First, however, I want to point out that the first six categories of large cap, mid-cap, and small-cap growth and value stocks are intended as long-term core holdings. Barring some unexpected development — such as accounting irregularities — the stocks I chose are meant to be held for at least ten years.
Income securities are a different beast. In the days before quantitative easing, there would be a healthy dose of both international and domestic bonds in the portfolio, along with a few real estate investment trusts or a REIT exchange-traded fund, also meant to be held for a very long period of time.
However, bond yields are virtually non-existent right now. In addition, at some point QE will end, which means everyone will sell bonds they have, which would result in capital losses. We don’t want that!
Instead, we must tread more carefully. This category is filled with securities that are dependent on the Fed’s actions. It’s difficult to say how the end of QE will change the composition of this asset class, or how quickly. So be nimble and ready to change direction.
Preferred stocks make for an excellent replacement for bonds, however. They trade like bonds in that their absolute price tends not to move very much, and most preferreds are in financially stable companies that are able to make those preferred dividend payments.
Remember, if a company is in trouble, it must first suspend common stock dividend payments, which gives you the chance to get out before the preferreds get hit.
I would anchor the category with the iShares S&P U.S. Preferred Stock Index (PFF). The ETF yields 5.78% and its top ten holdings only account for 14% of the overall index, allowing for a lot of diversification.
To that ETF, I would add Ashford Hospitality Trust (AHT) Preferred D shares, which yield about 8.4%. The hotel REIT has a solid capital structure and was one of the very few hotel REITs that didn’t cut its preferred dividend during the financial crisis.
Another good addition would be Public Storage (PSA) Preferred P shares, which yield 6.5%. Finally, we have RenaissanceRe Holdings (RNR) Series C Preferred shares, which trade about 6% below par and offer a 6.5% payout.
A utility ETF is a good idea here, and because I don’t know a whole lot about utilities, I’m satisfied with just holding the Utilities SPDR (XLU), which pays 3.77%.
REITs have had quite a run and are more exposed to stock price movement than preferred stocks are. Still, they offer good dividends and that’s why we’re here. iShares Dow Jones US Real Estate (IYR) pays a 3.77% dividend, and it holds some of the most important names in the sector, such as Simon Property Group (SPG).
I also like the common shares of Ashford Hospitality. If you want some riskier asset that has some capital gain appreciation possibility as well, add Hospitality Property Trust (HPT). It’s a bit overleveraged for my taste, but there is both capital gain upside and it pays 6.7%.
Remember, though, this asset class may shift on a dime. If bonds start selling off, we’ll eventually rotate some of this category back into bonds.
As of this writing, Lawrence Meyers was long PFF, AHT, AHT Pref. D. He is president of PDL Broker, Inc., which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books and blogs about public policy, journalistic integrity, popular culture, and world affairs. Contact him at pdlcapital66@gmail.com and follow his tweets @ichabodscranium.
