Disclaimers: Dan owns OSM, BAC PRE, GS PRA and GS PRD in his Covestor Taxable Income Model
The below text is licensed to Covestor Ltd. (“Covestor”), by Dan Plettner. Such text may be disseminated only by Covestor. Dan Plettner invests and receives income for securities research, including “buy-side” research. Dan licenses his own real time trading data to Covestor Ltd. (“Covestor”). Covestor is a Registered Investment Advisor that uses Dan Plettner’s data to create the Core, Long Short Opportunistic, Tax Advantaged Income, and Taxable Income models for its clients. Dan’s words should not be misconstrued as investment advice.
August 1, 2010: In my Taxable Income portfolio decisions, I find myself erring on the side of perceived risk-aversion. Whether exchange traded bonds like OSM which matures in 2017, or the floater preferreds issued by Bank of America (BAC) and Goldman Sachs (GS), I find myself choosing the reduced interest-rate risk that comes with adjustable distributions rather than the maximum current income that would come with static instruments. I’d obviously rather have the even juicier fixed yields of each issuer (ie: BAC-D, BAC-H, BAC-J, GS-B, etc) but those issues appear hazardous in my view.
I do not feel compelled for a Taxable Income portfolio to be dominated by traditional bonds or fixed-rate securities, particularly when I think Interest Rate Risk is excessive. FDI is among least disliked securities exposed to traditional interest-rate risk and I did buy some at $14.74 on June 7, when it was at a double digit discount. It’s nice not to be in love with underlying static-coupon bonds. I collected one $0.25 distribution and took profits at $15.87 on Jul 21. I don’t have aspirations of richness on trades, even if they generate $1.38 per share (or $1.37 after transactions costs). My point is that even when I feel so compelled by a perceived short term inefficiency to buy securities believed to possess interest-rate risk akin to typical bonds, I don’t do so emotionally.
Ideally, I prefer to minimize turnover. While it occurs at times via circumstance, I don’t try to buy distributions. Those who “buy dividends” can over time convert principal to taxable income. I suspect those who own securities like AOD and AGD (in which I’ve taken short positions at premiums at times in an alternate account with an alternate focus) which heavily rely on such a tactic wish that they had more principal, and were less taxed on the income that had been in effect largely converted from original principal by virtue of “buying dividends”.
Yield will never be the only thing to me. Not even close. I seek total returns in my Taxable Income Portfolio decisions. Principal is more important than yield. I savor the principal appreciation to maturity on OSM. There are risks to everything, including cash and money-market. In my view, the risk which is least rationally accepted by the investors absorbing it is currently the interest-rate risk inherent in traditional (static) bonds. When I look at the yield of traditional bond ETFs like AGG, BND, GLJ, BLV and VGLT, I think extensively about how much lower the prices could be when rates normalize. I think the risk is under-appreciated even by those on the short side of the curve; I don’t even like CSJ. I surely don’t own them.
When I make my Taxable Income portfolio decisions, I try to be both opportunistic and mindful of risks I take. One of those risks can be the possibility that I rely on an assessment outside of my core competency. In July, I may have missed an opportunity in Weyerhauser (WY) for the taxable income account I manage largely in the pursuit of managing this risk. I’m ignoring all the ill-founded taxable investors that bought Weyerhauser’s tax liability in the WY special dividend. Once WY traded “ex”, it was in many ways a uniquely repositioned instrument. Huge tax liability had been disbursed, and I believe single taxation of the REIT profile might be viewed quite advantageous by “Mr Market” when revaluing the publicly traded company going forward. But ultimately, a long term evaluation of Weyerhauser common stock is not among my core competencies. I did purchase WY in an alternate account in which I felt such a spirited liberty was appropriate, but I passed on Weyerhauser for all accounts from which I license data to Covestor. I expect to kick myself (hard) within six months, but discipline requires me to accept missing opportunities frequently.
