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Income and Discounts

11/04/2005 12:00 am EST


Richard Lehmann

Publisher, Forbes/Lehmann Income Securities Investor

When it comes to fixed-income investing, few can match the in-depth knowledge and experience of Richard Lehmann. He covers a wide range of income opportunities, including bonds, trusts, ETFs, closed-end funds. Here, he highlights a trio of current ideas.

"Because of my focus on fixed-income, I am not affected as much by bad news in the stock market. In fact, bad news for stocks if often good news for income investors, because there is a certain amount of competition for investment dollars between fixed income and stocks. If the stock market takes off, people shift more money into equities. Meanwhile, it now seems that the Fed no longer has the kind of influence that it used to have over long-term rates, because of the amount of activity from overseas. They don’t have any control over the imbalance of trade that basically goes into our fixed income markets. I think that accounts for a lot of the calmness of interest rates in this country.

"As for specific investments, we believe oil trusts should be a part of any fixed income portfolio. These securities yield upwards of 10% and are taxable at a 15% tax rate. Unlike US oil & gas trusts, Canadian trusts are able to replenish their reserves. So they are not depleting assets, in the way that US royalty trust are. So between the better tax treatment and the fact that these companies are permanent and not depleting, they definitely should be considered by any income investor.

"In particular, I would recommend PrimeWest Energy (PWI NYSE). The trust is 83% natural gas, with the balance in oil. And much of that natural gas is originated here in the US. The outlook for natural gas prices is much stronger than for oil. Consequently, this is very favorable for a trust with such a high portion of its assets in natural gas. The trust is yielding 10% now. Of course, you have to ask, will the dividends continue at this level? The trust set its dividend policy when oil was at $35 a barrel, so if anything, dividends are likely to go up, even if oil prices decline to $60, or $50, or even $45.

"Among sector funds, we are interested in the aging population of the US and the promise of emerging health care technologies. Population demographics will inexorably lead to increased utilization of healthcare. There are a number of ETFs and closed-end funds that cover this sector. The one we find most compelling is Blackrock Health Sciences Trust (BME NYSE). This fund offers a nice balance between healthcare providers, equipment, pharmaceuticals and the growth potential of biotech companies. The fund plans to make quarterly payments in the 38 cents per share range, which would mean a 6% yield at current prices. The expense ratio is high at 1.26%, but is somewhat offset by the 5.5% discount from net asset value.

"Among index funds, there are some closed-end funds trading at hefty discounts to their net asset values. For those who love a bargain, this class of funds is almost irresistible. We are interested in Tri-Continental (TY NYSE). It is the largest and oldest closed-end fund in the country. Its great size ($2.4 billion) gives it an advantage as its expense ratio benefits from the economy of scale. Its expense ratio is only 0.60, rivaling most ETFs. We are impressed with the quality of their holdings but are even more impressed with the 16% discount from net asset value the fund trades at. This means one can buy a dollar’s worth of stock for only 84 cents."

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