10 BARRON’S October 19, 2020
with an unprecedented array of measures
to make sure the funding markets resumed
functioning. To shore them up, it bought
not only Treasury and agency mortgage-
backed securities, but also corporate and
municipal bonds.
Result: Through Thursday, the stock
market, as tracked by the S&P 500 index,
was up 56% from its low of March 23, just
before the Fed’s aggressive policies were
announced. In dollar terms, U.S. share-
holder wealth has increased by about $14.
trillion, as measured by the Wilshire 5000.
For those who depend on interest earn-
ings, however, the story has been different.
Money-market funds now pay almost noth-
ing, as do most bank accounts. The bench-
mark 10-year Treasury note yields only
about 0.70%, which is less than zero after
taking into account inflation and taxes. (I
offered a few offbeat ways to earn a positive
return a couple of months ago, though some
of those rates have slid a bit since then.)
Obtaining substantially higher yields has
meant taking on higher risk. That has led
income investors to flock to corporate debt,
bidding up prices but lowering yields in the
process. For instance, theiShares iBoxx $
High Yield Corporate Bondexchange-
traded fund (HYG) is up 18.7% from its
March low, but yields just 5.30%, scarcely
living up to its name.
A better solution now would be to sub-
stitute the risk of leverage for credit risk,
says Harley Bassman, who manages what
he calls a “hedge fund of one,” while pub-
lishing an episodic macro commentary at
convexitymaven.com, which is well worth
reading for his observations on an array of
topics. He’s better known as the creator of
the MOVE Index, the bond market’s coun-
terpart to the Cboe Volatility Index, or
VIX, the stocks’ fear gauge, when he ran
Merrill Lynch’s mortgage operations in the
1990s and early 2000s.
One avenue he suggests is real estate
investment trusts that invest in mortgages.
These are simple in concept: They leverage a
portfolio of mortgage-related securities with
cheap short-term borrowings. “Presently, a
portfolio of brand-name mortgage REITs
yields about 10.50% and trades about 15%
below their June book value,” he observes.
ETFs such asiShares Mortgage Real Es-
tate Capped(REM) andVanEck Vectors
Mortgage REIT Income(MORT) yield a
bit more than that, 11.12% and 12.16%, re-
spectively, on a trailing 12-month basis.
Bolstering these funds’ attractiveness,
the Fed is now protecting both sides of
their positions. It has indicated that it will
keep its policy supereasy to get average
inflation above 2%. At the same time, the
central bank is supporting mortgage-
backed securities through monthly pur-
chases of $40 billion of them, as part of its
quantitative-easing program (along with
$80 billion a month in Treasuries).
While Bassman thinks that mortgage
REITs’ discounts could narrow, he doubts
that will happen until after the election
and after a fiscal package is completed,
perhaps sometime next year. “And despite
the S&P 500 near the highs, that is not a
comment on the economy, but rather on a
dozen stocks that mostly have monopoly
power. As such, credit risk should be
avoided and leverage risk substituted,
since the Fed will hold fund costs near
zero until 2023,” he writes in an email.
Another way to follow his advice is
through municipal bond closed-end funds.
As with mortgage REITs, these should be
bolstered by the Fed’s holding down short-
term rates and supporting the bond mar-
ket, he notes.
In addition, munis trade at lower prices
than they did before the coronavirus crisis,
while Treasury prices and muni yields are
higher. He cites a high-quality San Diego
School District tax-exempt bond due in
2047 and callable in 2027, which yielded
1.97%. That would be equivalent to a tax-
able 3% yield for most U.S. taxpayers and a
4% yield to Golden State residents subject
to California’s income taxes.
Muni closed-ends have the additional
benefit of that low-cost leverage, a diversi-
fied portfolio that typically trades at a dis-
count to net asset value and is listed on an
exchange with usually better liquidity. The
leverage and discount can result in a tax-
free yield exceeding 4%, equivalent to 7%
on a taxable bond. Bassman adds that in-
vestors should check a CEF’s undistrib-
uted net investment income, or UNII, to
see if its payout is sustainable, as he has
previously advised.
Indeed, the decline in borrowing costs
has resulted in a rise in distribution yields
on muni closed-end funds, according to
Sangeeta Marfatia, senior CEF strategist
at UBS Financial Services. The benchmark
for their borrowings has fallen to just
0.11%, from 1.50%. That has left leveraged
funds’ distribution rates hovering near 5%,
which should remain stable for a while,
she writes in a report.
Income investors may best parry the
Fed’s move to ultralow rates by using them
to boost yields, instead of getting knocked
down.B
email: [email protected]
Up & Down Wall Street Continued
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