Investing for income has never been harder. The Federal Reserve continues to indicate further interest rate increases are on the horizon. This makes bond buying dangerous for those seeking capital preservation in the face of rising rates.
This danger shows in the graph below, which indicates a strong probability of another rate hike at the Fed’s next meeting in June.
What makes this chart so interesting is that recent economic data doesn’t support the Fed’s conclusions. In the past several weeks, we’ve seen weakness in consumer spending, including negative consumer spending revisions, and falling prices. It goes without saying that falling prices aren’t a harbinger of a strong economy or strengthening GDP.
These are on top of abysmal auto numbers that show steep declines in sales and an exceptionally high 70-day supply.
Even so, higher rates aren’t exactly leading income investors to the Promised Land. While June might see another rate increase, it will only be the fourth such increase since 2006 — leaving rates in the 100-125 basis point range. The difference to income investors is negligible.
So what is an income investor to do?
Well, there are safe places for income investors to invest with better than average yields.
Take the Liberty All-Star Equity Fund (NYSE:USA), for example.
The Liberty Fund is a closed-end equity fund that truly invests in all-star stocks. The following table lists the fund’s top 3 sectors.
|Sector||Percentage of Assets|
The fund purchased most of the stocks in its portfolio when the assets were relatively undervalued. The fund has since rebalanced when valuations on its holdings have become stretched — in the same way that many value investors, like Warren Buffet, do.
And it works. The fund has averaged a total return of 14.3% return since the end of the Great Recession in 2009 while also trading at a 14% discount to its net asset value (NAV).
But for income investors, the best news is that Liberty All-Star Equity Fund yields an impressive 9.37%. That’s $937 in annual income for every $10,000 invested. And because the fund invests in solid stocks, the risk of higher rates will have no impact on an investor’s principal.
This makes the Liberty Fund a must-buy for investors looking for steady income.
Here’s another long term winner…
There’s another closed-end fund with an impressive track history. The Gabelli Equity Trust (NYSE:GAB) is a stellar performer. Since its inception in 1986, the fund has a total return in excess of 1,140%.
The fund belongs to legendary value-investor, Mario Gabelli, another student of the Graham-Dodd school of value investing. As you can see from the chart below, GAB is up more than 11% YTD compared to just 7.2% for the S&P 500 Index.
Currently, the fund is trading at a small 1.45% discount to its NAV, but income investors can take solace in knowing the fund has a distribution rate of 9.8%. This is in line with the company’s announcement in February of its intention to pay a minimum annual distribution of 10% of the average net asset value of the fund.
That means a $10,000 investment in GAB will throw off nearly $1,000 annually for investors. And just like the USA fund described above, rising interest rates will have a negligible impact on the yield.
Let’s look at a final closed-end fund to consider…
Nuveen Tax Advantaged Dividend Growth Fund (NYSE:JTD) may not possess the nearly 10% yields of the two previous closed-end funds, but an 8.3% dividend yield is still impressive at a time the 10-year Treasury remains at historic lows.
However, what sets the fund apart from other dividend funds is Nuveen’s approach to safety. First, 98% of the fund’s assets are in large-cap stocks, and no more than 20% of its assets are in any single sector. This helps reduce draw-downs in times of high market volatility.
But that’s not the only way the fund reduces risk. You see, the fund uses call options to reduce downside risk, while supplementing its purchases of common stock with shares of preferred stocks for their higher yields and lower beta.
But the fund is tax efficient, too. It focuses on long-term capital gains and qualified dividend income, which has the benefit of providing lower tax rates.
And don’t think a safe fund is likely to be a market laggard, either. The chart below shows a 12.6% gain YTD — again, against the 7.2% of the S&P 500 Index. And get this, despite the run-up in price, the fund still trades at a 6.9% discount to its NAV.
It’s proof that safety can provide outsized gains for income investors.
One Last Word
Fed Chair Janet Yellen may feel inclined to raise rates two or three more times this year. But whether she comes through or not, bond buying is inherently risky when rates are artificially low. Any sustained increase in rates will dramatically affect an investor’s principal. And a few basis points of yield aren’t worth the risk of declining account balances.
Risks To Consider: No matter what metric an investor applies to value the market, the market as a whole is fully valued to over-valued. Any significant market correction could put pressure on account balances, even with the inherent safety of investing in large cap securities.
Action To Take: Dollar-cost average into each of the funds over a period of several months. Continue buying shares as long as the funds are trading at a discount to their NAV. Mitigate your risk by using no more than 2% of your portfolio into any one of the recommended funds. These securities are long-term investments as long as the basic investment thesis remains intact.
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