Generational market tops like 1929, the 1970’s Nifty Fifty, and the 2000 Technology Bubble are frequently characterized by a group of leading popular stocks with parabolic charts and irrationally exuberant return expectations. In today’s market, the Magnificent 7 stocks and, to a lesser degree, the capitalization weighted indices like the S&P 500 (SPY) and NASDAQ 100 (QQQ), appear to be peaking. While unpopular, there is great wisdom in investing in attractive value investments found in less popular sectors and asset classes where investors don’t regularly traffic. Specifically, smaller capitalization stocks, value stocks, international stocks, emerging market stocks, and commodity stocks as well as commodities and money markets offer better return profiles than the Magnificent 7 or cap weighted index ETFs like the SPY and QQQ.
The chart below, by OPCO’s Ari Wald, shows that the relative performance of the equal weighted S&P 500 is rising versus the capitalization weighted index. This type of new leadership, outside of the popular megacap stocks and cap weighted indices, should emerge and persist in the years ahead.
Furthermore, the secular decline in interest rates and inflation, which commenced in 1981, ended around 2020 with inflation and higher interest rates. Investment strategies, like the 60/40 stock bond allocation, no longer offer the compelling return profile it did in 1981 and in the decades which followed. Consequently, we see wisdom in a 25% cash, 25% commodity, 25% stock, and 25% bond allocation for retirement assets and retirement income over the popular 60/40 strategy at the core of many financial plans and investment portfolios.
We applied our unconventional investment perspective to an income portfolio and created a stock and bond portfolio yielding 10.5% with moderate risk. This unconventional portfolio invests in high yielding closed end funds trading at a discount to net asset value (NAV), Master Limited Partnerships, and a high yield bond. Depending on the individual and their risk tolerance, a portfolio like this could be the 50% core stock and bond allocation in a 25/25/25/25 portfolio. By adding a 25% allocation to a 4.83% money market fund and a 25% allocation to commodities with no yield, our notional 25/25/25/25 portfolio would yield 6.46% and have more flexibility and inflation protection compared to a hypothetical 60/40 — 60% SPY and 40% TLT portfolio — which would yield 2.376%.
Below is a 25/25/25/25 portfolio with a 25% allocation into a IBKR money market yielding 4.83% and 25% into commodities yielding nothing. At the bottom of the chart we calculated the yield of the SPY and TLT in a 60% 40% allocation to represent a 60/40 portfolio yield for comparative purposes.
10.5% Yielding Portfolio Investments:
- TELZ is a Tellurian Baby Bond. The bonds mature on November 30 2028 at $25/bond and have an 8.25% coupon. The bonds trade a $13.90/bond and have a current yield of 14.83%. Tellurian Inc. is a distressed LNG project developer seeking to finance a 27.6 MPTA natural gas liquefaction facility near Lake Charles, Louisiana. The company’s principals have been involved with the building of 78% of US LNG production facilities and Tellurian is one of the few project fully licensed by the DOE and FERC making it the only major LNG project not hindered by the Biden LNG pause. With a nearly 4 year head start versus a greenfield LNG plant and nearly $1 billion invested, Driftwood is positioned to secure funding as the global energy markets are adopting LNG as a transition fuel to meet climate, economic and energy security concerns. Last week’s news of its planned sale of its Haynesville properties should retire the most problematic debt associated with Tellurian’s going concern, the company will need to announce more transactions like the Aethon Energy Management LLC’s (Aethon) HOA to off take 2 MPTA of LNG. Aethon, a large Louisiana E&P owned by EIG Partners, a major international energy investor, is the type of partners Tellurian will need to finance Driftwood. We believe this bond is risky, but could be a big winner if Tellurian succeeds in its financing or if the company is sold.
- GAMCO Gold, Natural Resources & Income Trust (GGN) is a gold and natural resource closed end fund that writes call options against its positions to add income to its portfolio. The fund yields 8.8% and has a discount to NAV of 1.5%. Historically, the fund has been positively correlated with positive moves in gold prices.
- Templeton Emerging Market Income Fund (TEI) is a closed end mutual fund investing primarily in the sovereign debt of emerging market countries around the world. It yields 10.49% and we expect emerging markets tend to perform well in the years ahead when the US equity markets consolidate.
- Kayne Anderson (KYN) is a closed end MLP oriented energy infrastructure fund that yields 8.89% and has a 14.9% discount to NAV. This fund uses leverage which enhances its yield, but can also lead to meaningful downside such as was experienced during the COVID crash of March 2020. We were aggressive buyers of KYN shares in the spring of 2020, and wrote about the rare opportunity in KYN shares in March 2020 in Seeking Alpha.
- Clough Global (GLQ) is a closed end fund trading at a 16.75% discount to NAV with a yield of 11.03%. GLQ is an attractively priced way to invest in many large cap technology stocks we have written about with lower risk. Microsoft, Amazon, and Alphabet are the funds three largest positions and are 17% of the portfolio. The distributions are likely to be more capital gains than interest income which some tax sensitive investors may dislike.
- Mainstay CBRE Global Infrastructure (MEGI) is a closed end fund with a 12.9% discount to NAV and an 11.5% yield. The company invests inglobal infrastructure properties typically associated with durable cash flowing businesses, but uses leverage which can be problematic in a major market decline.
- Abrdn Healthcare Investors (HQH) AKA Telka Healthcare Investors is a closed end fund trading at a 12.75% discount to NAV with a 14.25% yield. The fund invests in biotechnology, medical devices, and pharmaceuticals industries, and free cash flow generative smaller capitalization companies. HQH owns Amgen, Regeneron and Gilead Pharmaceuticals which represent about 20% of its portfolio.
- Energy Transfer LP (ET) is a leading Master Limited Partnership which yields 8.18%. It owns energy infrastructure assets in the United States including over 20,000 acres of natural gas pipelines. ET is even rumored to be a possible suitor for Driftwood LNG because its Lake Charles LNG facility has been impacted by the Biden Pause and Energy Transfer would be well positioned to transport cheap natural gas from the Permian Basin to Driftwood. MLPs pay distributions and not dividends, so they cannot be owned in retirement plans and require a K-1 filing each year.
- MPLX LP (MPLX) is the Master Limited Partnership subsidiary of Marathon Petroleum Corporation (MPC). Its yield is 8.36% and also requires filing a K-1 annually for its tax advantaged distribution. MPLX operates midstream energy infrastructure and logistics assets in two segments, logistics and storage, and gathering and processing.
- Western Midstream Partners, LP (WES) is a natural gas focused Master Limited Partnership with a 9.38% yield. Bond guru Bill Gross had cited WES as an attractive income idea and we like the natural gas focus – the cleanest of the three fossil fuels which will be needed for the next few decades.
Conclusion:
The benefit of the rise in inflation is the higher yielding investment opportunities which are now available. The ability to invest $1,000,000 and generate nearly $100,000 per year in income is quite compelling following a decade where money markets and bank deposits were nearly zero. For unconventional retirement minded investors, select closed end funds, Master Limited Partnerships, and certain distressed corporate bonds can offer attractive income generating investments that can help meet retirement planning goals.
Unfortunately, the liquidity of this portfolio is limited such that institutional investors cannot capitalize on these particular opportunities on any scale; however, this letter shows the benefit of unconventional income opportunities and investing in securities on the road less traveled. Whether this approach makes “all the difference” depends on understanding the particulars of each security.