JToday we’re going to make some shrewd moves worthy of the most cunning contrarians – and in doing so we’ll be grabbing reliable income plays that other investors are snubbing (with outsized returns of up to 8.6%) .
These moves run counter to the Federal Reserve’s planned rate hikes, which could begin as early as March, but that’s the whole point: Many people have let fear of higher rates scare them away from these investments. But as traditional investors almost always do, they’ve gone too far, setting us up well to capture those high yields and some price upside as 2022 unfolds.
Let’s start with our first move, which relates to longer-duration bonds, and specifically the closed-end funds (CEFs) that hold them.
The truth about bonds and interest rates
Stick with me for a moment, because I know that at times like these, when interest rates are about to rise, longer duration bonds can come under pressure. The reason for this is simple: imagine today that I lend someone $100 at 4% interest, then tomorrow I lend someone else $100 at 5% interest. Now imagine that I offer to sell you either of these loans. Which will you value the most? Obviously the one with the highest interest rate.
Source: CEF Insider
Therefore, as interest rates rise, the value of current bonds declines. Also, bonds that have a longer duration (i.e. the borrower has more time to repay the loan) lose value faster as rates rise because the money in the lender is locked into the loan longer as rates rise.
But this time, long-term bonds are path oversold, as shown in the chart below:
Short and long divergence
If we compare the Invesco Ultra Short Duration ETF (GSY), in purple on it, with the First Trust Long Duration Opportunities ETF (LGOV), we see that as you would expect the market is selling long duration bonds in exchange for short duration bonds because as we saw a second ago long duration bonds are more likely to lose value when interest rates fall.
However, in doing so, the market has already priced in the interest rate risk that long-term bonds face, which means that some bonds have been oversold because they offer good yields and relatively low risk.
In such a situation, your best bet is to buy a well-managed corporate bond CEF like the Western Asset II High Income Fund (HIX), an 8.6% yield which is well diversified in the bond space, with 270 holdings and an average duration of 6.25 years, which is a bit long, but remember, we are buying it because it buys these longer duration bonds when they are oversold. It holds 94% of its portfolio in corporate bonds, and these issues offer a good average coupon rate of 7.9%.
The fund is also trading at a slight discount to net asset value (or just below the value of the bonds in its portfolio) at the time of this writing.
The real reason we want a CEF like HIX, as opposed to a passive ETF like LGOV or the high yield benchmark SPDR Bloomberg Barclays High Yield Bond ETF (JNK), boils down to one thing: active management.
HIX is managed by Western Asset, which has been around since 1971 and has a management team with a keen eye on oversold bonds, which is why they’ve nearly doubled the yield of the high-yield bond index fund since inception. of this fund. (HIX has been around since 1998.)
HIX exceeds its benchmark
That’s exactly the kind of eye for value we want in a market like the one we’re facing right now. And best of all, HIX’s 8.6% dividend, which has remained stable throughout the pandemic, provides us with a stable income stream that far exceeds inflation.
Actions: Redux 2016
Now let’s move on to the second part of our contrarian high-yield plan, which is equities.
When rates rise, stocks can suffer, mainly due to rising borrowing costs: as companies have to pay more to borrow money, their profit margins will shrink and their stocks will thus lose value. This is why stocks fell in 2015, when the Federal Reserve made it clear that it was going to start raising interest rates (which it did in December of that year).
Stocks take a hit…
That’s the theory, at least. The reality, of course, is much more complicated. In reality, the Federal Reserve is likely to raise interest rates from zero to around 1% in 2022, which is still a fairly small amount to spend on borrowing money and not unlike the jump interest rates that took place in 2016 when, despite all expectations, stocks soared.
…but recover quickly
The simplest reason for this is that when the market realized that the relatively small rise in interest rates was not affecting corporate earnings (in fact, S&P 500 earnings per share jumped 29 % in 2016!), traders realized they had made a mistake selling stocks and buying them back.
At the start of 2022, it seems clear that history is repeating itself on the stock market. As is the case with longer duration bonds, now is a good time to buy a fund like the one at 7.3% Liberty All-Star Growth Fund (ASG), whose assets such as Amazon.com (AMZN) and Microsoft (MSFT), both of which have been oversold in this interest rate selling frenzy. And both of which have more than enough financial strength to cope with rising borrowing costs.
The fund is trading at a 5% premium to net asset value today, but the same is true for ASG. And it’s traded at much higher premiums (up to 15%) over the past year, so there’s a lot more room for its premium and by extension its price – to grow from here. .
4 other top income picks for 2022 (with 7.5% dividends, 20% earnings on tap)
The beauty of the CEF market is that it is small (with only around 500 funds). This means that it is mainly individual investors, rather than large institutional players, who buy these funds. And THAT means that we are regularly offered incorrectly priced offers!
the 4 CEFs I want to share with you here are perfect examples. They now fetch an outrageous 7.5%, on average, and they’re all trading at ridiculous discounts because the headline crowd ignored them. It won’t last, though, that’s why I beat the table More than 20% price gains of these smartly managed income coins this year.
All the details on these 4 essential CEFs await you. Click here for details including names, tickers, current yields, best buy prices and more.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.