I Am Buying Bonds And Preferreds, For Today’s Uncertain Times

Co-authored by Treading Softly.

Lifebuoys are often overlooked on watercraft such as boats, yachts, or cruise ships. However, these lifebuoys and the buoyant heaving lines they are attached to can be crucial in the event of an emergency. Even if you don’t think you’ll ever need it, it’s important to take note of where the lifebuoys are located on the ship. They could potentially save your life if you were to fall overboard. Often, we don’t pay attention to emergency equipment designed to save us, despite its obvious presence in our line of sight. How many times have you walked by an AED machine located on the wall of a public building without giving it a second thought? Yet, if you were having a heart attack and needed to be shocked back into proper rhythm, one of those machines could be the difference between life and death.

Historically, many investors were strongly encouraged to design a 60/40 portfolio — 60% in common equities and 40% in debt securities. The 40% allocated to fixed income will be less exciting and won’t grab your attention, but represents a vital part of your portfolio to keep your portfolio stable and alive. We all need some level of stability within our portfolios. I have a few positions that I view as anchor holdings, which I intend to keep in the eye of a storm. Yet, many investors neglect their fixed-income exposure, even though this asset class often rescues one’s retirement from the brink of calamity.

Today, I want to look at two different fixed-income-focused investments that can provide you with a high current income and great stability and strength to your portfolio.

Let’s dive in!

Pick #1: PDI – Yield 14%

In 2022, PIMCO snapped up more than $1.1 billion of discounted loans that banks were forced to clear from their balance sheets. Around late 2023, PIMCO began selling that debt at significant premiums and recently announced an expected $150 million in profit by betting the debt that Wall Street banks struggled to sell a few years ago would eventually rebound.

This is what PIMCO does, repeatedly and with a high degree of success. When Wall Street runs fearfully and throws the baby out with the bathwater, PIMCO rationally buys and holds, collects its waiting fees, and realizes the eventual significant upside. Through a high degree of diversification, the investment management company can navigate those few bad apples.

PIMCO sees an excellent opportunity in U.S. liquefied natural gas at this time of record export volumes. The firm is also bullish on the financial and consumer-oriented and maintains exposure to debt instruments from these lucrative sectors.

Among our PIMCO holdings, today we highlight the PIMCO Dynamic Income Fund (PDI) which sports an outstanding 14% yield. PDI is a CEF (Closed-End Fund) with assets invested in a worldwide portfolio of debt obligations and other income-producing securities, with current income generation as a primary objective. The CEF’s top holdings are closely tied to consumer-oriented sectors that remain in demand through inflation pressures. Source.

30% of PDI’s portfolio (measured as % of Market Value) comprises debt securities maturing in under one year, while its effective maturity is around 5.8 years. This positions the fund well for significant capital upside upon maturity while providing a steady high yield from a sizeable portion of its portfolio for a few years to counter the effects of rate cuts.

Since its inception in 2012, PDI has delivered growing distributions to shareholders, including several bonus payments. The CEF’s current $0.22/share monthly distribution calculates to a sizeable 14% yield, the highest among our PIMCO holdings.

Fixed income is an excellent place to invest amidst discounted valuations and a broader fear of higher-for-longer interest rates. PDI allows you to collect large distributions as you wait for NAV recovery through eventual interest rate cuts.

Pick #2: GOOD Preferreds – Up To 7.9% Yields

Gladstone Commercial Corporation (GOOD) is a public REIT focused on acquiring, owning, and managing primarily industrial and office properties. The company invests in single-tenant and anchored multi-tenant net-leased assets, with an emphasis on industrial products, which bodes well in the current push to boost domestic manufacturing capabilities in the United States.

GOOD owns ~17.1 million square feet of predominantly industrial and office real estate assets, and its portfolio is diversified across 135 properties in 27 states leased to 110 different tenants across 19 industries. The REIT ended FY 2023 with an occupancy of 96.8%, and this metric has never dropped below 95% since becoming a public company in 2003.

14.4% of GOOD’s total lease revenue comes from the company’s top 5 tenants, and the weighted average remaining lease term for the portfolio stood at 6.8 years as of December 2023. The REIT maintains a strong balance sheet, with 90% of the debt fixed or hedged, and $51.5 million available under its revolving credit facility. The REIT ended FY 2023 with $16.1 million in cash and cash equivalents. A minimal amount of debt is due in 2024 and 2025 and is easily manageable with the REIT’s available liquidity. Source.

Investors needn’t fret over GOOD’s allocation to office properties. This segment of the REIT’s portfolio is mostly laboratories, research centers, workshops, and other location-dependent occupations that are immune to the disruptions from remote work and other aspects affecting the Commercial Real Estate market.

GOOD pays monthly dividends on its common and preferred stock. The $0.10/share common stock dividend calculates to a 9.1% annualized yield. GOOD spent $47.9 million on common stock dividends, a sub adequately covered by its $52.9 million FFO (Funds From Operations), at a 90% payout ratio.

While we like GOOD’s business fundamentals and portfolio composition, we seek safety higher up in the REIT’s capital structure and choose to invest in its cumulative preferreds.

GOODN and GOODO are attractively priced preferreds that pay monthly dividends and yield up to 7.9% at current prices. GOODO presents a good buying opportunity with ~30% upside to par. The REIT spends $12.3 million on preferred dividends, which are adequately covered by its operations. With a growing push for domestic industrialization, we expect the REIT to have ample opportunities to grow its portfolio and establish long-term leases with credit-worthy and location-dependent tenants.

Conclusion

Using fixed-income investments, as we’ve discussed above, your portfolio will generate consistent and strong income. This can be a reliable cash flow that flows from the market into your account, allowing you to survive even in the harshest of recessions. PDI and its managers have been able to carefully bob and weave through the fixed-income market and benefit because of their more profound understanding of how the economy works. They are experts in credit markets, and leveraging their skills will let you enjoy a strong income. PDI will provide you with the economic return of a diversified fixed-income portfolio.

GOOD preferred shares allow you to benefit from a company that is actively supporting the basis of American manufacturing. There’s little to dislike when it comes to a homegrown dividend, especially when it’s adequately covered by the cash flow of the company. Directly owning preferred shares like these, provides you with a predetermined fixed dividend. I own an entire portfolio of preferred shares like these, from dozens of different companies. This portfolio provides me with a predictable and stable base of dividends, upon which I can build the rest of my portfolio.

In retirement, you should never neglect the 40% of your portfolio that should be allocated to fixed income. The last 2–3 years have been extremely rough for fixed-income investments as far as their trading value is concerned. However, very few investors have suffered losses on the income they generate, highlighting the much-needed stability they bring to your portfolio. At the end of the day, if you’re living off the dividends or the interest income, it doesn’t matter what the trading valuation is. All that matters is what is pouring into your account from them. So, when those investments go on sale, you should go to that sale to buy as much as you can. As an income investor, we always have cash pouring in to make these opportunistic buys.

That’s the beauty of my Income Method. That’s the beauty of income investing.