Putting the pieces together...

Some Ideas on mREITs

The meat of this blog post comes from a big trader/investor in mREITs , some of which I own. There are a few comments I made on my own very small experience. I do own AGNC, CMO, ANH, and MFA plus preferreds of the last three.



 

YEAR END REARRANGEMENTS

The US Central Bank, Congress, and President are still in that fortunate middle place where the consequences of their actions or inactions have only modest effects, whether positive or negative. This is why postponing real solutions is still an attractive option, seemingly the only one at high levels. And the real private economy is showing some life, at the margin.

Markets are waiting to see what happens, or consolidating, within fairly narrow ranges. The central and private banks are encouraging each other to buy government securities and profit on the spread between artificially low short term rates and much higher, proportionally, long term rates. This does several things. First it helps fund government largesse from otherwise sustaining very large deficits. Second, it guarantees bank profits which helps increase their capital for future lending. Third, it destroys faith in government and its currency. Fourth, it wrecks the plans of savers, whether for retirement or for future investment.

In this middle period it doesn't make sense to get very extended as an investor, whether for stocks, bonds, or gold or commodities. I have mainly been in bonds, high yield stocks of all kinds, and gold for the past five years. A major reason was due to retirement when one can ill afford the volatility which leads to large losses.

This year it has seemed to me best to mimic what the FED is trying to do for the banks: own government agency mortgages and bonds. My largest single position has gradually become Vanguard's VFIJX Ginnie Mae Fund which is fairly low duration and government guaranteed, paying ~3.3% on a four year maturity paper. I have beefed up yields somewhat with mREITs which leverage up the yields of Fannie Mae, Freddie Mac and other government agency securities. The mREITS do what banks do but "only" at 4-8x leverage instead of 15-30x. They are paying 10-20% dividends. Also some of them have preferred shares paying 8-9%, and I have mixed the two classes to about 10-12% of the VFIJX holding. Also I have LSBDX, which is mainly high yield BONDS plus Canadian treasurys, TEI which is emerging market sovereigns (small position), and PIMCO's unconstrained short term bond fund, PFIUX. I recently added Doubleline's Total Return Fund DBLTX, recommended by several posters here, which is also heavily weighted in government agency paper but which is, as with PFIUX and LSBDX, chartered to go anywhere.

These are held mainly in the tax deferred funds. Gold and  gold and silver funds (CEF, GTU, ASA, GDXJ and bullion) are held in taxable accounts plus starting positions in FPACX and PRPFX as explained recently. Several oil and gas trusts and Gabelli and Eaton Vance closed-ends which write options on long stocks also pay 8-10%. Cash and near cash are held for further purchases of these  into weakness, especially the named mutuals.

Ironically, I see both deflationary and inflationary trends continuing, as they have since 2003: deflationary in government areas and inflationary in private areas. But gold and real estate are likely to continue consolidating in 2012. Don't sell if you own, but don't buy unless prices fall down under 1500 in gold.

This isn't guaranteed by anyone, least of all by me. I can and do change as events prove me right or wrong. Think clearly and always consider capital risk your real enemy.

 

Comparisons

I own all of these funds. LSBDX is my favorite, but it is aggressive and volatile. Kathleen Gaffney is heir apparent and recent spokesman at LSBDX. She's good.

VFIJX is Vanguard's GNMA fund and my largest overall portfolio position. Steady Eddy. PFUIX the PIMCO unconstrained bond fund is a close second. These are "near cash" to replace zero interest rate money market funds.

Notice that LSBDX has been outperforming PRPFX the past three years. It has done so also since 1991, and is why I think one can do better with first rate more focused funds, however much we (and I) would like a simpler solution.

 

 

Simple All-Inclusive Portfolios

The header or title may sound self contradictory, but how to sample the investment universe simply and in an equal weighted manner over very long periods of time is the goal of many investors. They want to make one decision, once only, and live without ever making changes, except perhaps for re-balancing to bring each component back to a chosen and fixed percent of the total portfolio.

 Balanced mutual funds in the US do this by SEC-approved charter. For instance, Vanguard's Wellington Fund, begun in the 1929 top year, dedicates about two-thirds of its portfolio to over 100 stocks and about one-third to over 400 bonds across all economic sectors. The fund has returned, averaged annually, 8.11% since July 1, 1929 through last week. Vanguard has other stock and bond balanced funds as do many other US fund companies. The theory is that stocks and bonds do not always go up and down together or in the same percentages, so if one class goes down, the other may go up and neutralize, partly or in total, a decline in one. Also price volatility or risk may be lower for the whole fund.

Until the 1920's few investors invested in stocks, so a balanced fund with two-thirds of assets in stocks would have sounded pretty radical to many. But the marked inflation of World War I, the first war fought by the US under the Federal Reserve, and for which no specific war taxes were raised, had hurt bonds, and the fabulous rise in stocks from 1921 got the public interested in stocks. So Wellington Fund reflected that history and public interest.

The recurrence of marked inflation in the late 1960's and 70's, also without specific war taxes, made bonds a bad word and led to increased investment in gold stocks, silver, and US TBills eventually paying rates well over 10%. TBills (US or Swiss) and gold was a frequent slogan of alternative investors of that era who shunned both generic stocks and bonds due to their generally very poor records from 1966 to 1982.

It's natural to have some cash in an investment portfolio since cash reduces volatility of a stock and bond portfolio, increases income, and is available to make new purchases. Likewise many investors added some gold stocks, which were mainly South African and paid high dividends, from the 1950's on. After 1975 when US investors could buy gold bullion, some investors preferred the metal to gold stocks.

Julian Snyder, Harry Schultz, and Harry Browne were three well-known alternative investment gurus of the 1960's and 70's who recommended portfolios including gold, commodities, and currencies in addition to stocks and "some" bonds. None of them was a big fan of traditional bonds. My own first gold coin investment was made through a Harry Browne plan. Browne's ideas gradually coalesced into developing a one-stop fund which would own stocks, bonds (US and Swiss), cash (US and Swiss), and gold. He realized that each of the four had a place in a portfolio, and each had its time to outperform, whether in inflation, deflation, growth, or recession. Rather than analyzing or guessing which class to own now, own them all and keep owning them all, just like Wellington Fund, but with more cash plus gold. And instead of weighting the classes based on market sector value or fundamental beliefs, own each of the four classes in equal dollar amounts and rebalance to equal dollar amounts once a year or more. Think of each class as a separate portfolio, but put them into one convenient commercial package, namely a US mutual fund.

That mutual fund, Permanent Portfolio Fund (PRPFX) has now been in place for 29 years. It still holds nearly equal amounts of growth stocks, gold and silver (25% total), Swiss and US TBills and Swiss and US T bonds. Over the years Browne himself favored different components for each class, but the concept of four equal portfolio classes remained the same. Since 1982 PRPFX has returned an annualized 6.82% while Vanguard Wellington returned 10.43%.  Crawlingroad.com has championed the use of ETFs for each of the four asset classes but leaving out Swiss cash and bonds. I personally don't see any inherent advantage to this ETF approach over PRPFX . I could only find yearly returns for the 1982-2008 period from the Crawlingroad site to compare with PRPFX (founded in 1982) and Wellington Fund. For that period the unaudited figures, without mention of costs and slippage for Crawlingroad, show 6.86% (average annual gains) compared to 7.05% for Vanguard Wellington and 5.78% for PRPFX.

For investors, Crawlingroad would require more accounting and tax time, and the time for rebalancing than either PRPFX or Vanguard Wellington. Some also fear the legal structure of ETFs compared to mutual funds, not to speak of indexing concerns for stocks, and not to mention issues in long term rebalancing itself. 

Since I am primarily interested in investing IN retirement, I do very much like the reduced volatility that the PRPFX and Crawlinroad products offer even with returns smaller than Vanguard Wellington. After all, you pay for what you get, so if you want reduced volatility, it costs you a bit. My own portfolio is structured a lot like PRPFX and Crawlingroad, except I have much higher percentages of bonds and near cash to reduce volatility even further. You can't afford huge annual volatility drawdowns in retirement! But if you have thirty years until retirement, and you don't want to devote the time learning how to invest and actually doing it, the PRPFX or Crawlingroad aproach could be a quite reasonable way to go.　

1982 to present has provided incredibly diverse bull and bear markets in all four classes in PRPFX and Crawlingroad, even in cash which yielded well over 10% per year in the early 1980's and virtually nothing now. Nevertheless it's not at all clear that equal dollar amounts of cash, bonds, stocks, and gold is a superior portfolio than more traditional stock and bond balanced funds like Vanguard Wellington, which came out very well despite the last ten to twelve years of  underperformance.