Alternative Income Ideas

11/04/2005 12:00 am EST

Focus:

Mark Skousen

Editor, Forecasts & Strategies, High-Income Alert

Economist, professor, scholar, and advisor, Mark Skousen is an expert’s expert. At one workshop, he focused on his specialty of finding alternative strategies for seeking high income. Here, he looks at some lesser-known ideas for generating yield.

"There is no free lunch in high income investing. You must be alert to possible changes, and you need to use protective stop loss orders. You have to look at crises – when people are dumping things – as an opportunity to be a contrarian and buy. If you are looking for both capital gains and high income, you need to buy at the right time. Where are some good investment opportunities right now?

"The first one is the Aberdeen Asia Income Fund (FAX ASE). Previously called the First Australia Income Fund, this fund is a real bargain right now. FAX dropped below $6 a share recently, while its net asset value is $6.40, so there is a huge discount to net assets.  I really like is 'commodity income investing'. Southern Peru Copper (PCU NYSE) is yielding about 10% and the dividend is growing. Copper is near an all-time high and Southern Peru is growing by leaps and bounds. But be aware that commodities are inherently volatile, and, therefore, this is a very volatile stock. I also recommend Freeport McMoRan (FCX NYSE), which has the largest copper/gold mine in the world. It is based in Indonesia, so there is political risk. But the stock has done very well, the company is doing very well, and I am very bullish on its prospects.

"We’ve recently seen a 10% decline in Canadian oil & gas trusts, and I’d like to see even more of a selloff. But one new Canadian oil & gas trust that we are recommending is Harvest Energy (HTE NYSE). It is paying 35 cents per share (Canadian), which gives us about a 12% yield. What are the risks? Steve Forbes is predicting that oil could drop to $35 a barrel. If that happens, then the energy trusts could drop 50% in value. Another risk is that these companies often pay out more in dividends than they are earning. It’s a return of capital and no company can pay out these kinds of yields forever. So they are expanding into new production to pay these high dividends. When the expansion stops, then they will cut dividends. So you need to be aware of this.

"Meanwhile, another area in which bargains are developing is in mortgage REITS. Many have fallen by 40% to 70%. Why? They had record revenues while the Fed was creating low interest rates, and now with the Fed raising rates, revenues are slowing down. Few people have been refinancing. And real estate prices are leveling off. When it becomes clear that the Fed has stopped raising interest rates, then you should buy mortgage REITs. Thornburg Mortgage (TMA NYSE) is a good quality company and the stock has been hammered. It’s yielding 12%, and I’m very tempted to buy now. But I would wait until there is a general consensus that the Fed is done tightening. At that point, this REIT will really begin to rally.

"Finally, another area that I am really excited about is business development companies (BDCs), which might be considered the greatest income secret on Wall Street. It’s a way to earn high income and participate in the economic growth of this country. There are thousands of private companies out there that are expanding and engaging in acquisitions. To do this, they need financing. BDCs finance these private venture capital companies.

"Allied Capital (ALD NYSE) yields 8% and dividends have been increasing over time. The value of the stock has been increasing. American Strategies Capital (ACAS NASDAQ) is also yielding 8%. There is no evidence that the top has been reached for these companies. These BDCs finance companies through equity loans, through bridge loans, mezzanine financing, etc. They loan money and they earn a very high interest that is passed on to investors. In addition, they often get equity kickers. The end result is that the total return can be 20%. We note that Allied Capital is a little more risky, due to an SEC investigation. But from everything I see, I think this risk is built into the price right now. But if you’re concerned, then focus on American Strategies, or Apollo Investments (AINV NASDAQ), which is a fairly new BDC.

"Another BDC that I like is Quest Capital (CA:QC Toronto), which finances Canadian companies. Canada is booming economically. The government is running a surplus. Quest is a BDC that specializes in financial Canadian oil and gas firms, mining companies, forestries, water companies, and other firms dealing in natural resources. The stock currently trades on the Toronto exchange, but should soon be trading on the American exchange. Unlike the other BDCs, this one is young and has not yet started to pay a dividend. Once it does, I think it will be comparable to other BDCs, and pay 7% or 8%, while also allowing us to participate in these expanding venture capital deals. They recently did a new stock issuance to raise money. That usually dilutes the stock. But that is over with now, so it seems like blue skies ahead now for this company."

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