Carla, what do you see as the most promising areas for income
investors in 2009?
The market turbulence of 2008 triggered a massive
flight to safety as investors ran from even the faintest
hint of risk during the last few months of the year. We've
uncovered some assets that look attractive in light of this
Among them: exchange-traded bonds. In September's issue
of High-Yield Investing, we introduced
subscribers to these securities, which trade like stock.
They're listed with a ticker symbol on a major exchange and
can be bought and sold during the trading day as easily as
you do any stock.
These bonds are the ultimate income security.
They're even more secure than preferred shares. That's
because as "senior" debt they're higher in the financial
pecking order: Companies have to pay bondholders before they
can pay dividends.
Unlike dividends, which are discretionary and based on
earnings, bond payments are a legal obligation. They
must be made on scheduled dates at a pre-determined level. Plus, bonds also have a set maturity date
when investors get back their principal. The company can't
default on these payments unless it becomes insolvent or
bankrupt. That's the risk, but the market has priced in far
more risk than companies seem to be facing -- particularly
those with investment-grade ratings of "BBB-" or higher from
Standard & Poor's.
One winner from this category is our "High-Yield
Security of the Month" for December 2008, which has rocketed +60%
in less than eight weeks. That's on price alone,
without taking a penny in interest into account. Its
next quarterly payout is due in early February, so total
returns, which include price appreciation and interest
income, will be even better. Even at today's prices,
this investment-grade bond still offers new investors a
double-digit yield of about 11%. That's about four times
better than the S&P 500, but this payout is guaranteed --
the company is legally obligated to pay it.
That sounds like a great opportunity for income
investors. Is there anything in the high-yield universe that
you would steer clear of?
Cash-strapped companies with debt that's coming due are
too speculative for our investment style.
Real-estate owner General Growth Properties (NYSE: GGP), for
instance, sports a juicy triple-digit yield, but the company
is trying to extend a deadline for paying off a $2.6 billion
credit line and a $900 million mortgage that's coming due.
The company has reportedly said they're not going to file
bankruptcy, but the dividend outlook is far too uncertain
for our taste.
We also tend to steer clear of certain highly leveraged
closed-end funds. Some of these funds offer enticingly high
yields, but their distributions aren't as secure as we like
to see from our investments. Safety is always first.
For example, a fund like Nicholas-Applegate Convertible
& Income (NYSE: NCV) leverages about 40% of its portfolio
assets. That means almost half its assets are based on
borrowed money. In next month's issue of High-Yield Investing,
we'll explain how
these funds are required by law to cover debt by 200% to
300% of assets, and they may be compelled to cut or suspend
their distribution in order to do so. Even with a rich
yield, that's just too much risk.
Last year was devastating for most sectors, if not
most companies. Were you able to find any pockets of
Last year was tough, and dividend payers didn't escape
unscathed. Dividend cuts were common, even from
long-time payers like Bank of America (NYSE: BAC), which
hadn't missed a dividend in over a quarter of a century but
had to trim its payout to conserve cash.
The slowing economy and tight credit markets could
impact earnings and lead more companies to want to conserve
cash instead of paying it out to shareholders. Also, some
companies that paid fourth-quarter dividends in 2008
announced dividend cuts that will start in 2009. So we could
see the full effect of these dividend announcements in the
first quarter of 2009, and it may take another year or so
before the overall dividend picture improves.
That said, we found several high-yielding companies
that actually increased their payouts, even despite the
worst economic conditions since the Great Depression. In
November's issue of High-Yield Investing, for
example, we unearthed more than a dozen stocks with yields
of 6% or more that had the wherewithal to ratchet up their
dividends. For example, cash-flow dynamos like pipeline operators
have sailed smoothly through the eye of the storm, and they
should lead the charge as the markets start to recover.
Are there any strategies you use that can help investors
gauge dividend safety?
Most of the safeguards involve taking a good, hard
look at the financial statements and usually the notes to
the financial statements as well. For example, we look at
the balance sheet to see what kind of long-term obligations
the company has and what kind of cash is available to pay
these off. We also take a good look at the notes to the
financial statements to find out when a company's debt is
coming due. Then we can assess if it has ample cash flow and
cash reserves to cover this debt plus continue paying out
shareholders at the current rate.
We don't expect our readers to do that -- that's what
we're here for. Before we present any investment idea, we
scour through the financial statements to ferret out the
details of the company's financial performance and
liquidity. We then use our findings to size up how safe the
dividend appears to be in the months and years ahead.
Asset-coverage ratios are also handy, especially in
sizing up the safety of a closed-end fund's distribution. In
the upcoming February issue of High-Yield Investing, we will be telling you how to apply this simple but
effective ratio. You can then use it to see if any of your
funds are in danger of a dividend cut.
What's your No. 1 focus when picking income investments?
I would have to say risk/reward is my main measuring
stick. Generally, the more risk you are willing to take, the
more potential reward you can expect.
Investors have to decide for themselves how much risk
they can tolerate in return for the potential reward.
Readers of High-Yield Investing are spread
across the risk tolerance spectrum. That's why I like to
present a range of opportunities, thought I myself tend to
be somewhat conservative.
In fact, I'll reveal a little secret of how I write
High-Yield Investing. In my spare time, I also teach writing. I always tell my students to imagine their
audience sitting in front of them as they write. Well,
one member of my audience is my mother. In fact, she's
right in the first row. She lives off the income from
her investments, which I manage. I ask myself, "Is
this security suitable for my mother?" If so, I rate it as a
conservative or reasonably safe investment idea. If
not, I consider it suitable for more aggressive investors.
We conduct a lot of research to help us gauge the
risk/reward potential of a security. The Securities and
Exchange Commission's free website is one of our favorite
hunting grounds. It allows us to dig through current and
historical financial statements and pore through the notes
to the statements to get a good reading on the company's
performance and liquidity.
Even so, the financial statements just show a point in
time. That picture can change rapidly as management
responds business conditions. The bottom line is that every
investment carries some risk, even Treasury bills,
money-market funds or even a CD. Investors must weigh how
much risk they are willing to stomach in return for the
potential reward. I see my job as helping them to see
clearly the risk and the reward potential. In the months
ahead, I look forward to providing my fellow investors with
income strategies that offer exceptional value in a market
that has become deeply oversold.
-- Carla Pasternak
Global Dividend Opportunities
Note: If you'd like to learn more about Carla
Pasternak's High-Yield Investing, we encourage you to
this link. Not only will you learn more about how to
access some of the most attractive income investments on the
market today, you'll also learn about
Carla's "Income Security of the Month" for January
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