Co-produced with “Hidden Opportunities”
Since the start of the pandemic, our economy has been given a major boost by the US government. Months of massive quantitative easing and stimulus checks have left Americans swimming in big money, driving a monster rally from lows in March 2020. The investing community is increasingly bullish on markets, buying every falling and sending the major indices to new highs.
As the Fed announced its decision to scale back bond purchases and raise interest rates, leading market analysts issued warnings of limited upside in equities over the coming year.
“Consumer and investment spending will continue to drive the economy next year, but we will return to a more normal rate of growth.” – Ed Yardeni, President of Yardeni Research
With inflation high, high growth stocks should see their valuations decline due to their price multiples based on their projected 2024 earnings. deep fix. The real test for an investor is when the market experiences a correction. Black Swan’s predictions and extremely believable (and possibly logical) bearish thesis have spread like wildfire, turning old “diamond hands” into “paper hands”.
“It’s only when the tide goes out that you find out who swam naked.” – warren buffet
In times of uncertainty, dividends offer the comfort of predictable returns, a must-have for someone looking for reliable passive income. With a quality dividend-paying stock portfolio, you never have to time the market to unload stocks to generate income. This is a proven method, as dividends have been responsible for more than 30% of total S&P 500 returns over the past 100 years. Their contribution is most significant in bearish phases and market corrections.
In this report, we discuss two undervalued high-yield picks that are excellent to hold in an inflationary environment and stand to benefit if the Fed continues to raise rates, and will provide your portfolio with substantial cash flow no matter what. he is coming. Without further ado, let’s get to those choices.
Choice #1: ECC, 10.2% efficiency
Leveraged loans and their CLO tranches are floating rate instruments that are priced at a spread above a reference rate (LIBOR). As interest rates fluctuate, CLO yields increase in sync. The floating rate returns of CLOs make them an effective hedge against inflation, making them highly desirable for income investors.
Many investors shun leveraged loans because of their conceptual similarity to CDOs and MBS, responsible for the Great Financial Crisis (“GFC”). But CLOs are much lower risk than corporate debt, and other securitized products do. It should be noted that no AAA or AA CLO tranche has ever suffered a loss in principal.
Eagle Point Credit Co. (NYSE:ECC) is a CEF comprised of capital and junior debt tranches of CLOs and is managed by the knowledgeable and experienced credit company Eagle Point. The company is the highest rated for leveraged loans and was recently awarded “Best Closed CLO Fund” by Creditflux, a leading global news source covering credit funds and CLOs.
ECC’s November update reported NAV in the $13.56-$13.66 range, down from $14.23-$14.33 in October. The irrational Mr. Market interpreted this as bad news and drove the stock down.
Looking objectively at the loan market, November was a record month for loan issuance in a record year. Loan issuance broke all previous records.
As a result, the portfolios of loan managers were full. They couldn’t buy more loans without freeing up cash by selling the loans they had on the books. This in turn caused a massive increase in new CLO issues. After averaging $15 billion per month through October, November saw $25.6 billion in new CLOs issued.
Each new CLO issued signifies a new equity position that the loan manager is trying to dump into the market. It doesn’t take an economist to conclude that prices fall when supply exceeds demand.
As a result of the GFC, debt markets were forced to reassess and tighten their underwriting practices, thereby increasing coverage ratios. This makes CLOs very sound and structurally safe income investments. Fitch expects CLO default rates to be 1.5% for 2022, down from 2.5-3.5% expected earlier this year.
ECC’s net asset value growth has been more than impressive in 2021. Following outstanding performance, ECC declared a special dividend of $0.50/share to shareholders.
ECC has been a rewarding income investment over the years. Since its IPO in 2014, ECC has paid out $14.9 in cumulative common distributions. That’s a total return of 78% in 7 years, with no reinvestment of dividends. Today, this CEF is trading significantly below its average lifetime premium to NAV. This is a rare opportunity for investors, given that the demand for CLOs is the highest today.
ECC’s monthly dividend of $0.12/share corresponds to an annualized return of 10.2%. As floating rate instruments, CLOs inherently benefit from rising rates, and ECC’s generous dividend is an excellent hedge against inflation. All in all, a fantastic addition to your income portfolio in today’s volatile, inflationary and yieldless market.
Choice #2: ORCC, yield 8.5%
Business Development Corporations (“BDCs”) generate revenue by lending and investing in small and medium-sized private enterprises. BDCs generate income based on the difference between interest income from portfolio investments and interest expense from borrowings/debts. Contrary to popular opinion, BDCs are well positioned to succeed in a rising interest rate environment because their loans come with floating rates. This means that as base interest rates rise, BDCs will see higher net interest margins and higher net investment income (“NII”). And because this is BDC, a higher NII automatically means higher dividends for shareholders.
Owl Rock Capital Corporation (NYSE: ORCC) is the third-largest publicly traded BDC by market capitalization and is externally managed by Owl Rock, a leading BDC franchise with over $34 billion in assets under management. Owl Rock is led by a founder with leadership with over 25 years of diversified lending experience.
ORCC holds investment grade credit ratings from all major rating agencies. As of November 2021, BDC maintained $2.4 billion in cash and unused debt capacity, which is among the highest of any BDC. It carries a debt of 1.06x on equity. More than 76% of its debt matures in 2026 or later, giving it enormous flexibility to use its cash flow and continue investing in this booming economy. The third quarter NII of $0.33 per share is higher than the quarterly distribution of $0.31. Excess income is retained to maintain dividends during quarters when the NII may be lower than the dividend.
ORCC has strong exposure to the highly resilient and essential sectors of the economy, namely internet software and services, insurance, financial services, healthcare providers and services, and food and beverage. ORCC’s highly disciplined investing is evident in the composition of its portfolio. More than 77% of investments are in senior debt and 15% in junior debt, which the company says they only issue to highly resilient companies. An increased allocation to senior secured debt ensures capital preservation and predictable returns for investors.
ORCC’s selectivity in lending and investing is evident from the results. In the third quarter of 2021, more than 91% of the portfolio is performing at or above expectations.
Today, ORCC is available at a 2% discount to its net asset value and yields 8.5%. Not only is it capable of beating inflation, its variable rate investments ensure that your portfolio will thrive as rates rise over the next year and beyond.
Investing in dividends means we pay the price to buy a stream of income. We don’t hope or pray for returns; our portfolio will produce regular income like clockwork. When times are tough and the market sees a sell-off, we can pay less to buy higher yields.
The best part about income investing is that you don’t have to chase the next big thing and keep watching it like a hawk to make sure the tide hasn’t turned. There’s a lot of noise today with COVID-19, Federal Reserve policy changes, uncertainty over the Build Back Better Act, rising rates, geopolitical issues with China. No matter which direction the wind is blowing, more income is always better!
Today we’re discussing two heavily discounted income choices that can boost your income stream in the new year. The best part is that both have floating rate assets that are meant to amplify your income as interest rates rise. These CEFs are led by highly experienced teams in their respective fields and have a combined yield of 9.3%. You can sail through market corrections with returns like this and come out with pockets full of cash.