Compound price

The market is down, my income is up

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Co-produced with Treading Softly

The market has been a real downturn for many. That seems to be all investors and retirees can focus on. Well, that and the higher cost of gasoline. Oh, and don’t forget the higher cost of races.

Ironically, all those higher prices also increase government tax revenue. If the same purchase is now more expensive, Uncle Sam also receives more money from you.

So there is a lot of depression in 2022. I remember a friend telling me that he dreaded saying 2021 because he seemed to say “2020 won”. I wonder what this friend thinks of 2022. “2020 two” looks like a sequel to 2020, and to many investors it might look like a sequel to a movie where the original wasn’t so great.

So what can you do on a bad day or a bad year? Do not lose hope. Focus on the good things in life.

I spent the morning writing this article and spending time with my family. We enjoyed the warm sun, played in the grass with our Bernese mountain dog and listened to our hens sing their egg songs.

It may not be your way of life, and that’s okay!

I also enjoy seeing my annual dividend income increase in my portfolio – between dividend increases, reinvestment of dividends in the best opportunities available, and falling stock prices driving up returns, I see my army of banknotes d a dollar be even more effective than last month.

When investors in the market are desperate about falling stock prices, I accept falling prices as a way to see my income grow even faster. To that end, members of High Dividend Opportunities are seeing their earnings grow, and even faster than before.

This is a key part of our income method. Take the income you need and reinvest the rest for future growth. With a well-constructed portfolio, you should never need to sell a stock. Instead, you’ll still be a buyer, using excess dividends to buy more stocks and own more assets. Lower prices are always an advantage for the buyer.

Let’s look at two possibilities to help your income grow quickly.

Pick #1: OXLC – Yield 13.9%

Oxford Lane Capital (OXLC) invests in CLOs (Collateralized Loan Obligations). A CLO invests in “leveraged loans”, senior secured loans with variable rates and generally granted to companies with a B/B+ credit rating. The CLO then sells “slices” of debt to institutional investors.

When the underlying borrower pays its principal and interest, the funds are then distributed among the tranches of the CLO based on seniority. The A tranches are paid first, then once they are fully paid, the B tranches are paid, and so on. Conservative institutions like insurance companies and banks will pay high premiums to be on the front line.

OXLC runs on the other end of the line, it invests in the “equity” tranche. While the senior debt and junior debt tranches all receive a pre-determined interest rate, the equity tranche receives what is left over. Which, in today’s environment of very low defaults and low equity prices, is a lot.

CLOs have spent the past two years selling debt tranches at massive premiums. The lower the interest rate of the debt tranches, the more remains for the equity tranches!

Below is an overview of OXLC’s current cost performance. (Source: Presentation to investors Quarter ended March 31, 2022)

Presentation to investors Quarter ended March 31, 2022

Presentation to investors Quarter ended March 31, 2022

You will note two yields: “Effective yield” and “Cash distribution yield”. Effective yield is what OXLC reports for GAAP earnings, this takes into account that some borrowers will default on their obligation. When they do, OXLC is in a first loss position, so any default immediately reduces OXLC’s return. Effective yield uses historical default rates and assumes the future will be similar.

Cash Yield is the amount of cash that is currently being distributed to OXLC at this time. The environment is extremely friendly, with default values being rarer than hen’s teeth.

TCW

TCW

These are all-time lows, so when looking at OXLC’s expected returns, we probably shouldn’t be counting on a 29% return on their investments, even if that’s what they’re getting right now. The “effective return” of 16.1% is reflected in OXLC’s GAAP net income, which was $1.02/share for the past 12 months. Comfortably covering the $0.90 dividend.

In other words, even if defaults reach historical averages, which would be a massive jump from here, OXLC’s dividend is still covered. If defaults remain extremely low, then OXLC will continue to hedge the +190% dividend. The reality will probably be somewhere in the middle.

OXLC easily hedges its dividend now and will easily hedge it in a wide range of future conditions, and that’s even before we factor in growth. What did OXLC do with all that extra money? He bought new CLOs.

When CLOs are new they do not pay out immediately, it takes some time before distributions start being made on equity positions. Just like when you buy a dividend stock, you may have to wait 2-3 months before you receive your first dividend. In June, more than $400 million in investments will make their first distribution to OXLC.

Presentation to investors Quarter ended March 31, 2022

Presentation to investors Quarter ended March 31, 2022

It’s $400 million in principal that OXLC is already paying interest on the debt, but it hasn’t started receiving payments yet. The $456.9 million that has yet to be paid represents approximately 1/3 of OXLC’s entire portfolio. Cash flow is high now, once these positions start paying they will be even higher!

OXLC is making money in spades. With default rates likely to remain well below average for the foreseeable future, this trend is set to accelerate. OXLC’s share price has sold since the start of the year as investors worry about book value and prices for debt investments decline. We are happy to wake up and feel the cash flow and see a huge dividend.

Choice #2: RQI – Yield 6.9%

When the market decides to crash during earnings season, it can create special opportunities. With indices swinging 3% and more in one day, selling becomes blind. Everything sells, even companies that have declared very good results.

A sector that crushed first quarter earnings and has an extremely favorable outlook for 2022? REITs. American Tower Corporation (AMT) beat profits and increased its dividend, Prologis, Inc. (PLD) raised its forecast thanks to the NOI (net operating income) of comparable stores which should increase from 7.25 to 8% in due to historic rent increases, and Public Storage (PSA) announced an agreement to sell PS Business Parks to Blackstone for a $2.3 billion gain to be distributed to shareholders as a special dividend, and the list goes on.

REITs are having a good year, with inflation driving up rents and real estate values. Meanwhile, REITs have very little exposure to inflation-sensitive spending. There are many great buying opportunities. While not all of them fit my income goals, luckily there is a solution.

Cohen & Steers Quality Real Estate Income Fund (RQI) includes all REITs mentioned above in their top 10 positions. It provides immediate exposure and diversification to the REIT sector. The best part is that the market oversold it. CEFs (closed-end funds) trade on the open market, so the price can, and often does, deviate from the NAV (net asset value). In other words, the price of the RQI is different from the purchase price of the same shares.

RQI is now trading at a 7% discount to NAV.

Chart
Data by Y-Charts

This means that we have three ways to take advantage of the RQI. We will gain throughout with a high dividend, which will provide us with recurring cash flow. We get paid to wait for REITs to recover.

We will take advantage of this when REIT prices recover, as they should take into account the strength of earnings and the very positive outlook for most REITs. When the market recovers, REITs should be one of the leading sectors.

Finally, when REITs rally, sentiment towards the RQI will turn and the discount will close. The market is also likely to overshoot the upside, which could result in the RQI trading at a premium to the NAV.

This is why I like to invest in CEFs when the market becomes particularly volatile. The market almost always overshoots, being too bearish on the downside and too bullish on the upside. When you identify a sector that is likely to outperform, investing in a CEF that specializes in that declining sector is a great strategy.

Cohen & Steers has been one of the best CEF managers in the REIT industry, and RQI is up for sale!

Conclusion

When the market is selling, it is important to evaluate your choices and ensure that there is no weakening fundamental reason for the price to drop. The falling tide will lower all ships. The key is to make sure your ship doesn’t run aground and get stuck.

Once you have ensured that there are no rising fundamental risks, it is time for your dollars to bring you even higher returns than before. Warren Buffett has said that the stock market is a means by which the wealth of the impatient is transferred to the patient, and I agree. I do not sell in worry or fear any of my holdings that do not present significant high risks.

I am a patient and well funded income investor. My wallet keeps pouring more and more income into my coffers, allowing me to reinvest money and buy what others are selling in fear and worry.

You can join me. Your retirement will thank you. You will earn the right to claim credit for your success.

Let’s do it together!