Here’s the ultimate rate-proof bond fund. It pays a monthly dividend, good for 5.1% annually, and delivers total returns between 10% and 15% yearly when the Fed is raising interest rates, asserts income expert Brett Owens, editor Contrarian Outlook.
If you buy a 10-Year Treasury bond today (even after its recent rally) you’re getting just 3% (more or less). Your interest payments are secure, but your principal is at risk as rates continue to rise.
Floating-rate bonds don’t have this problem. They have variable coupons (interest payments) that are calculated quarterly, or even monthly. Their rates take some reference rate (such as the federal funds rate) and add a defined payout percentage to it. As the reference rate ticks higher, so does the coupon’s payout.
The best deals in the corporate bond market are actually just below the somewhat arbitrary investment grade cutoff. It’s where contrarian fund managers and investors like us capitalize on the fact that overly conservative pension funds, banks, and insurance companies are not allowed to invest in these “low quality” issues per their by-laws.
The result is a sweet spot of value, thanks to the lack of big money chasing these types of bonds. You just have to pick and choose the quality companies with plenty of cash flow to service their debt obligations.
My preferred way to invest in this market is with my favorite floating-rate bond fund that today pays 5.1% yearly (and has double-digit price upside potential, too.) It hires the best bond managers on the planet to build a portfolio for us. And we can even get them to work for us for free if we buy the fund today!
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The BlackRock Floating Rate Income Strategies Fund (FRA) buys floating-rate debt. Most of the bonds it buys are issued by corporations, and most of them are below the somewhat arbitrary demarcation of “investment grade.” Again, it doesn’t matter what a rating agency says. What matters more is the actual health of a business, its cash flow, and its ability to service its debt.
BlackRock’s managers C. Adrian Marshall and Josh Tarnow also take advantage of the absence of big buyers in these debt pools to secure a blended yield of 5%+. Hart and Marshall love the Bs — they’ve got 90%+ of the portfolio in BBB, BB, or B rated debt (investment grade is AAA, A, or BBB).
They’ve outperformed the Barclays U.S. Aggregate Bond Index (a proxy for the fixed income market) over the last 1-year, 5-year and 10-year periods. That’s impressive because rates just recently started to move upwards.
It’s a fluid portfolio that’s constantly mapped to BlackRock’s current view of the financial world along with specific companies and their ability to pay their loans. They like good companies with stable cash flows (to pay the debt).
The fund currently holds a mix of 553 holdings across various industries. They’re mostly issued by domestic companies, with 94% based in the U.S. and Canada.
Its current distribution is well covered. Over the last three quarters, it earned 103% of the cash it’s paid out as investment income. And remember, its 5.1% yield is quoted net of fees. And since we’re able to buy at
a discount to its net asset value, we’re essentially able to get our management fee comped.
FRA charges a 1.06% management fee, which is reasonable in CEF-land, especially from an excellent firm like BlackRock. And we can take advantage of the current 3.7% discount to NAV, buy the floating rate high-paying bonds and get the great managers tossed in for free.
