This column originally appeared Jan. 31 on RealMoney. We're running it today as a bonus for TheStreet.com readers. To subscribe to RealMoneyclick here.
My mother recently retired after a 43-year career in the computer software industry, and she asked me to create her retirement portfolio.
With her retirement, she wanted to make 8%-10% annually, which is more than any money manager could get given current interest rates.
Additionally, she wanted liquidity (the ability to take money out), which is something a hedge fund couldn't give her since they typically have one-year lockups.
She also wanted transparency, the ability to look at her portfolio on a daily or (God forbid) hourly basis.
And finally, she wanted low volatility, which is very difficult to get when aiming for returns higher than the 4%-5% returns of T-Bills.
First, I do not believe it's possible to make 8%-10% with no volatility. There will be down periods as well as periods that make more than 8%-10%. But I do believe it's possible to put together a portfolio with the following characteristics:
- "Do no evil": My main concern was to make sure no pick was at too much risk of losing money. This is more important than making money.
- Yield: Since income is important to my mom, most of the picks have to spin out a good amount of cash.
- Diversification: I focused on the following areas in pursuit of diversification:
Number of picks: There's various academic research on what constitutes a diversified portfolio. I've seen reports suggesting anywhere between 15 and 125 picks. I settled on about 20 picks that I liked for her.
Beta: Meaning diversify in correlation to the U.S. markets. If the domestic market goes up you won't go up as much, but if it goes down you won't go down as much.
Fund family: My intent was to put her into several closed-end funds, but I didn't want her to be exposed too much to any one fund family.
Type of yield: In other words, balancing municipal bonds, preferred stocks, U.S. Treasuries, corporate bonds (focusing on high to medium quality, the lower the quality the higher the yield), global, bank loans, inflation indexed, duration (the average length of a loan), etc. Every type of bond has different characteristics, and while they are all largely correlated to interest rates, a high-yielding corporate bond will not necessarily go up or down the way a municipal bond might if interest rates keep going up -- which they are unlikely to do after 13 straight increases.
Track record: In particular, I wanted to make sure the funds had good track records in the 2000-02 period.
Discount to net asset value: All of the closed-end funds I picked trade on the
New York Stock Exchange. Many of them trade at prices that are lower than their net asset value. In other words, if they hold $15 a share of assets, they might trade at $14. If you buy at $14 and the next day the fund decides to liquidate, then you get $15 of assets. It's been shown in various academic studies that funds trading at a heavier-than-normal discount to their net asset value tend to appreciate more than their peers (and, of course, give a higher dividend).
My goal was to find closed-end funds with all of the above characteristics that were also trading at larger-than-usual discounts to their net asset value. Additionally, if hedge fund activists like Opportunity Partners, Karpus or Western were also in the fund, then that gave me comfort because I could assume they had done their homework on the holdings of that fund and were comfortable with it. Furthermore, they might try to open up the fund, in which case there would be a chance for quick capital appreciation.
Here's a selection of the vehicles I put her in.
Nuveen Preferred & Convertible Income Fund
: 8% yield. Based on its 12% discount to net asset value there's probably another 5%-10% price appreciation potential here, or at least a cushion against a market slowdown.
John Hancock Preferred Income Fund II
: 8.23% yield.
Preferred and Corporate Income Strategies Fund
( PSW): 8.64% yield. It invests mostly in the bonds of BBB-quality and below issuers, and it is spread out across real estate, oil and gas, and industrial companies.
The fund is trading at its lowest discount to net asset value since going public in the summer of 2003. I expect there to be some price appreciation based on this discount closing. Additionally, I like the yield.
First Trust Value Line Dividend Fund
: 3% yield. This is a conservative way of playing the stock market. The fund invests in high-yielding but slow-moving equities. This is trading at a 12.3% discount to the net value of the assets in its portfolio, providing some cushion against a market fall.
Evergreen Managed Income Fund
: 8.51% yield. Like PSW, this fund is also trading at its highest-ever discount to NAV.
I spoke with Andres Lucas from the closed-end fund specialist hedge fund, Global Partners LP, about ERC. "We don't believe the dividend is in jeopardy, as we are quite bullish that the
will stop raising rates sometime in the first half. It trades at a 12.73 discount to NAV and yields 8.51%. It does get down to 8% discounts frequently, which means you might get 12% if the div holds up and without NAV risk."
Municipal Bond Plays
All the yields included below are taxable equivalent yields, assuming the highest tax rate. The actual yield is lower but as I said, these funds are tax-free, so this is the taxable equivalent based on the highest tax rate.
I like the New Jersey muni-bond funds because my mom lives in N.J., enabling her to avoid state taxes on the income from these bonds. Additionally, I don't believe you can go wrong investing in bonds backed by the Port Authority of N.Y. or bonds backed by the Rahway Valley Sewer Authority. These bond funds are trading at a higher discount to net asset value than usual, perhaps because of concerns about the recent transit strike.
BlackRock Insured Municipal 2008 Term Trust
( BMT): Taxable equivalent yield 7.4%. This fund owns a diverse group of municipal bonds and each bond is insured against risk of default. For municipal bonds, I've been selecting funds with relatively low duration, meaning the bonds are due soon. This allows them to roll over into higher interest bonds if interest rates go up. The only bad scenario for a fund like this is if interest rates go to 8% from 4% in a very fast time frame. (Note that this scenario is much worse for any bond fund other than for a low-duration fund.)
Colonial High Income Municipal Trust
: 9.49% taxable equivalent yield.
Dreyfus Municipal Income Fund
: 9% yield.
Putnam Managed Muncipal Income Trust
: 8% yield.
Salomon Brothers Municipal Partners Fund
: 8.16% yield.
Salomon Brothers Municipal Partners Fund II
( MPT): 8.85% yield.
Eaton Vance New Jersey Municipal Income Trust
: 8.26% yield.
MuniYield New Jersey Fund
: 7.3% yield.
It was also important to get exposure to global income plays as well, hence my inclusion of
Strategic Global Income Fund
, 8.78% yield, and
BlackRock Global Floating Rate Income Trust
, 8.15% yield.
Corporate Floating Rate Loans
Over the past year, the discounts to net asset value of the closed-end funds specializing in corporate floating rate loans has gone a lot higher as interest rates have gone up. Global Partners' Andres Lucas says that the selloff is far overdone, leaving opportunities in both yield and capital appreciation as these discounts close.
First Trust/Four Corners Senior Floating Rate Income Fund
( FCM): 7.93% yield. The discount to NAV is at its highest ever.
Nuveen Floating Rate Income Opportunity Fund
: 8% yield. Its discount to NAV is at 8.43% and has gone steadily down for the past year.
I also wanted her to have some exposure to stocks, but mostly value-based stocks that might hold up better in a recessionary environment. I particularly like the Royce family of funds so she owns shares of
Royce Focus Trust
Royce Value Trust
Royce Focus has handily beaten the
every year since its inception, and I particularly like that it was up 9.7% in the recession year of 2001. Similarly, the Royce Value Trust was up 14% in 2001 and has beaten the S&P each year as well.
I wanted some exposure to tech, but I like getting that exposure through secured debt backed by solid assets and cash flows. I've written several times about
, run by ex-Merrill analyst and Royce mutual fund manager Jonathan Cohen. In fact, this is one of my picks in the Internet Review portfolio. TICC is a business development company that lends to private technology companies via convertible debt. In other words, they get the benefits of debt (secured by assets, decent yields) but also the benefits of equity if any of these companies turn into homeruns.
I also put her in the
Torch Royalty Trust
. This very illiquid trust basically collects the profits from various oil and gas properties located in Texas, Alabama and Louisiana, and distributes those profits as dividends. I like the fact that activist hedge fund Barington has quietly become one of its largest shareholders. My guess is the fund views the market as undervaluing the assets of these oil and gas properties and at some point it's going to attempt to shake things up to unlock value. It's not so bad to collect the 9% yield while my mom waits for that to happen.
Please note that due to factors including low market capitalization and/or insufficient public float, we consider Technology Investment to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.
At the time of publication, Altucher and/or his fund was long Torch Royalty Trust, although positions may change at any time.
James Altucher is a managing partner at Formula Capital, an alternative asset management firm that runs several quantitative-based hedge funds as well as a fund of hedge funds. He is also the author of
Trade Like a Hedge Fund
Trade Like Warren Buffett
. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Altucher appreciates your feedback;
to send him an email.
Interested in more writings from James Altucher? Check out his newsletter, TheStreet.com Internet Review. For more information,
TheStreet.com has a revenue-sharing relationship with Trader's Library under which it receives a portion of the revenue from purchases by customers directed there from TheStreet.com.