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When it comes to analysing The 25% Cash Machine, an investment newsletter launched this year, I must admit to starting with some scepticism. I have never quite understood the business model of newsletters – you would think stockpickers would make more money, and their subscribers could invest more cheaply, if they simply launched a fund to make the investments they are recommending.
Excessive marketing claims – of the “Let me tell you about the three stocks that are GUARANTEED to at least DOUBLE by CHRISTMAS” variety – by some newsletter writers have also helped give the genre a bad name.
In the case of The 25% Cash Machine, the title will strike many people as very ambitious. But it conceals an interesting strategy. And the mere existence of such a newsletter is fascinating. Traditionally, newsletters are given to hyping potential short-term growth stocks. The meticulous job of grinding out a higher income from dividends – and potentially a higher long-term total return from reinvesting them – is nowhere near as exciting.
So it is encouraging that such a newsletter has reached the market. An “aggressive income” approach, where investors sacrifice some hopes for growth in return for a big dividend, makes sense in the current environment. And Bryan Perry, who is writing the newsletter for Changewave, a group usually known for growth investing, generally avoids hyperbole.
The arguments for hunting for yield are good enough. Baby boomers are approaching retirement, and so the fund management world will need to improve its income investment skills.
With the markets still turbulent after a correction, holding on to the relative safety of a high dividend makes sense. In the very long term, research suggests 96 per cent of equity returns are attributable to reinvesting dividends.
So how is Perry’s system of “strategic high-income investing” supposed to work? The aim is to find securities that appreciate by 15 per cent a year, while paying out a 10 per cent yield. This, he says, can be achieved with a turnover of 15 per cent of assets each year. It also involves trading across a number of asset classes. Some are naturals, such as real estate investment trusts (reits), which pay out high yields from their rental income and look a better buy after a correction this year, and preferred stocks, which also make stronger payouts than ordinary stocks. Other asset classes are more obscure.
For example, Perry’s list includes Canadian Royalty Trusts, which are traded natural resources stocks. The trust owns the company and distributes almost all the income to shareholders. They are also tax efficient. These are core holdings of the fund. Plainly a high exposure to energy has worked out well recently but it may be optimistic to expect the trend to carry on. Perry names six royalty trusts as viable candidates for his readers’ portfolios.
Perry also recommends closed-end funds, which routinely attract the attention of value investors as they often trade at a discount to net asset value. The funds he lists as possibilities again signal an eclectic approach, ranging from blue chip value funds through to utility funds – another traditional staple of income investors – to a fund investing in Spain.
Another category he recommends could make sense in the current environment: convertibles. These have the potential for an equity-style uplift if the underlying stock stages a rally and also pay a predictable dividend. He recommends investing in the sector through funds, with Calamos, a house that built its reputation largely on convertibles, at the top of his list.
He also avoids stock-specific risk when looking at junk bonds, a sector that is unavoidable when trying to pull off a combination of high yield and growth. He recommends investing in the sector only through funds, and comments drily on the bad image it has suffered since it melted down amid Fed tightening in 1994: “It is like trying to tell a local fisherman that Dow Chemical has stopped dumping toxins into the river and it is OK to eat the fish.”
Other intriguing offerings include equity-linked securities (ELKs), one-year debt securities issued by Citigroup with a relatively high fixed coupon, master limited partnerships (MLPs), a vehicle of choice for the oil pipeline industry, which allow a direct share in the revenue generated by pipelines and oil wells but crucially do not allow any voting rights. MLPs are relatively tax efficient, as they are taxed only at the level of the holder of units in the trust, and do not pay corporate tax on top of this.
Perry is also prepared to dabble in bridge or mezzanine financing, where there are high yields to be made financing the current wave of mergers. There are certainly risks in this portfolio – a global economic slowdown would inflict particular damage on transport stocks, and it is easy to envisage scenarios where real estate and oil suffer capital losses, even if they continue to pay the income. But the yields should offset some of these risks.
In the current environment, where significant absolute returns require an appetite for risk and imagination, this strategy has a role. And so, perhaps, do newsletters.