Making Hay: Tracked Portfolio Edition
Figures & Percentages
“The average high yield bond’s credit rating (supposedly an indicator of quality) has risen substantially…large numbers of investment grade triple-B-rated companies have opted to increase their use of leverage and allow their rating to slip to double-B, the upper tier of the high yield bond universe.” -Oaktree Capital Management’s co-founder and acclaimed credit market investor, Howard Marks.
Hello, Subscribers!
As promised, this is the second installment from yesterday’s Making Hay Monday (MHM). This is focused on my template for how an investor might go about constructing an income portfolio.
First, I realize most readers have been primarily striving to generate capital gains. Yet, given that the bulk of you are in the mature chronological category, I think that’s a mistake. Further, it could be an extremely costly one.
Next, please be aware these are just rough guidelines in terms of the section weightings (such as 15% in mortgage-backed securities). This is where most of you need the assistance of a trusted financial advisor who knows your own situation, risk tolerance and, perhaps most critically, how you react to adverse market conditions.
Lastly, in the past, I’ve repeatedly said on podcasts and written in these pages that it’s a very tough space to operate in as a retail investor… but I know many of you will anyway! Therefore, I will do my best to provide you with guidance on why the below may make sense to be constituents in your personal yield-oriented portfolio.
In almost all cases, these are securities I personally own. Many have been in my portfolio for years, even decades with some of the pipeline issues (like EPD).
A preeminent reason I think most of you should care about this new Haymaker service is that I’m convinced capital gains are going to be much harder to come by in the years ahead, at least with the long-favored market segments such as tech.
In my view, there are opportunities, but they tend to be where most American investors have little to no exposure. Gold and the gold miners have been a classic example of this apathy toward an area with a powerful tailwind. At this point, though, their future upside has been considerably diminished by their strong performance this year (and with gold in 2024).
Naturally, a key advantage of income securities is the cash flow they produce. In most instances, that is highly dependable. However, with equity income issues there is always the risk of payout reduction or, even, elimination. Many of the midstream entities, primarily pipeline operators, have endured that, particularly during Covid. (Frankly, those who made it through that cataclysm without cutting or omitting deserve special attention, in my opinion; EPD is the poster child for that type of dependability, having boosted its payout almost every quarter since it went public in 1998.)
The recent selloff in the midstream space has, of course, raised their yields. As you will see below, they are quite attractive. Another positive for those seeking income is that the yields on corporate bonds have moved up sharply. High-grade corporate debt now provides a return of roughly 5.6% on 5- to 10-year maturities.
For those rated less-than-investment-grade — aka, junk bonds — yields presently are around 9%. Higher-quality junk yields, per the Howard Marks quote, are closer to 7½%. (Personally, I’ve long had an affinity for BB-rated bonds; numerous studies have shown they provide the best risk-adjusted returns in the corporate bond world.)
Okay, let’s get to the income portfolio overview….