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Barbell Strategy Boosts Annaly

05/28/2015 7:00 am EST

Focus: REITS

Mark Skousen

Editor, Forecasts & Strategies, High-Income Alert

Our latest featured recommendation is a real estate investment trust that doesn’t actually own or manage real estate, asserts Mark Skousen, editor of High-Income Alert.

Instead, Annaly Capital Management (NLY) borrows short-term and then buys higher-yielding securities, especially mortgage securities.

Since inception, Annaly has paid more than $12 billion in dividends to shareholders.

The securities that Annaly Capital owns are very liquid and allow the company to always know the true value of its assets. Those assets are extremely high quality.

Of course, mortgage rates are awfully low right now. So management has put 13% of shareholders’ equity into commercial real estate and corporate debt.

Annaly employs what is known as a barbell strategy. It invests partly in securities that will outperform in a period of rising rates (floating-rate securities) and partly in securities that will benefit from falling rates (fixed-rate securities).

The company also has invested hundreds of millions of dollars to hedge its assets and dampen the impact of rising rates.

In the meantime, with short-term interest rates near record lows, there is good money to be made earning the spread between short-term and longer-term rates, especially since Annaly uses leverage. 

Annaly borrows to increase returns, yet it is far less leveraged than the typical bank, which employs 30 to 1 leverage, or a thrift, which generally uses 25 to 1 leverage. Annaly typically uses just 8 to 12 times leverage.

Because Annaly is a REIT, it is required to pay out at least 90% of its earnings to shareholders as dividends. That’s why the shares sport a huge yield of 11.8%.

The stock is cheap, too, at less than 80% of book value. The insiders recognize this situation. 

Co-Founder and Chairman Wellington Denahan-Norris recently purchased more than $1.8 million worth of the stock. Chief Financial Officer Glenn Votek recently bought 25,000 shares.

It wouldn’t be a bad idea to follow their lead. We recommend buying Annaly Capital Management at market. And place a protective stop at $8.50.

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