THIS IS NOT INVESTMENT ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN
As a yield hunter, the persistance of low interest rates has been frustrating. Allegedly to aid the economy, the Federal Reserve has kept the cost of funds to banks near 0%. This has benefitted big banks by providing record low cost of funds. Indeed, the total cost of funds (e.g. CD rates, saving account interest, borrowed funds) for banks in the first quarter of 2010 was 1.03%, the lowest EVER. The wide spread between the cost of funds and interest that banks charge borrowers for loans has helped banks to boost profits from loan activity to record levels and to replenish balance sheets bruised by the collapse of the subprime market. But, it makes yield hunting difficult.
I have countered this situation with a combination of approaches.
First, I have invested in the trust preferred shares and the debt of large financial institutions whose balance sheets and reputations are still damaged. As discussed previously, trust preferreds count as Tier 1 (equity) for banks which is one mutliplier against which their lending limits and other ratios are determined. Paying 7% or more is still considered by these banks as cheaper than the cost of raising money through common stock issuance especially while the reputations of these institutions are still impaired (many still are not allowed to pay dividends on common stock by the government as punishment for requesting TARP borrowing). I have done well with the trust preferreds of Deutsche Bank, Aegon, ING, Citi, JPMorgan, MorganStanley, FifthThird and BankAmerica. I also have invested in the exchange traded debt of other financials damaged by the 2008 crisis such as GECapital, Ford Credit and AIG. I am averaging well over 7% on these plays, but recent purchases don't yield nearly as well---a fact which goes to prove the improving balance sheets. These should hold steady until redeemed which likely will not occur for a few years. Remember----most of these have a redemption price of $25---don't pay over that even if the yield otherwise justifies it.
I have also invested in enterprises that are sufficiently credit worthy to take advantage of these interest rates, using the leverage inherent in low cost borrowing to their advantage. Mortgage REITS such as Annaly Capital, Anworth Mortgage and Chimera purchase mortgages and enhance the returns by using cheap short term borrowing. This can give them a 100% margin which to the investor results in double digit distributions (10-15%) to shareholders. Although each hedges the cost of borrowing, they will be less attractive once the cost of borrowed funds increases. I will sell once I see that on the horizon.
I have also invested in leveraged closed end funds. For example, leveraged municipal bond funds can pay distriibutions of 6% or more (equating to taxable yields of 9% or more) by using inexpensive borrowing to purchase higher yielding municipal bonds. These will likewise become less attractive once interest rates increase.
The key to each of these plays is LIQUIDITY. I look for exchange traded securities which have a daily volume of 100,000 or more. I do not take a large position in any of them; so if necessary I can exit quickly and silently. Being nimble is one advantage that the small investor has---TAKE ADVANTAGE OF IT.
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