Co-produced with Treading Softly
I hate to see wasted potential. It saddens me to see possibilities that never arise simply because the time, effort, or energy has not been expended to realize them.
I recently saw a WWII Jeep Willys on parade. It has been beautifully restored. Someone put in a lot of effort to get the engine running right, to get the paint scheme and tires right, it was a work of driving art.
I’ve also seen the exact same vehicle idle in a farmer’s field, exposed to the elements and rusting. The potential for an excellent, fun-to-drive car awaits someone who wishes to unleash that potential.
It is likely that this will never happen. All that wasted potential. A real shame!
For many of us, our portfolios are operating near their peak performance. However, among the investment community, we have a number of us who are sitting on wasted potential in our portfolios.
We are talking about their liquidity. Losing value due to inflation and not gaining anything significant while losing that value.
Cash as an emergency savings tool is valuable as cash and should not be confused with an “investment” in one’s wallet.
The money left in his wallet is a Pyrrhic victory. Sure, it sounds great that it “beats the market”, but in all honesty, that doesn’t matter. If you sit on it, it will lose to the market on the next rally. It does not pay dividends, it has simply lost value over time. You may be “winning”, but even when you win, you lose.
It’s time to put that money to work. Collect excellent dividends and take advantage of the timely market recovery.
Let’s dive into it.
Choice #1: ARCC – Yield 8.9%
Ares Capital Corporation (ARCC) is a premium BDC (business development company) that has stood the test of time. One of the oldest BDCs listed on the stock exchange, ARCC is one of the few companies in the sector to have been tested under the difficult conditions of the Great Financial Crisis.
BDCs are direct lenders to middle market businesses. These are companies that are not usually listed on the stock exchange, but are still quite large. ARCC focuses on the upper middle market segment, with the average borrower having an EBITDA above $170 million per year. These are much larger borrowers than most BDCs invest in, and ARCC can focus on this segment due to its size.
ARCC has the perfect business model for a rising fare environment. The majority of the loans it grants are at variable rates and the majority of the debt it borrows is at fixed rates. Thus, as interest rates rise, the ARCC collects more interest, while the interest it pays remains fixed. The combination of higher income and lower expenses means a better bottom line. (Source: Quarter ended March 31, 2022).
A 100 basis point increase from March 31 rates adds $0.23 to basic EPS. A 200 basis point increase adds $0.44 to basic EPS. Rates have already increased by 140 basis points, which means that ARCC’s income is already increasing at this time.
So let me clear things up. The CRA has:
- Increase of its regular dividend by 2.4% in the first quarter.
- Announcement of an additional dividend of $0.12 to be paid in four quarterly installments throughout 2022.
- Net asset value increased to $19.03 in the first quarter.
- Expects basic earnings per share to increase +20% for the remainder of the year.
- Will benefit even more if interest rates continue to rise, as the market expects.
With all of these tailwinds, ARCC should be trading at a larger premium to NAV. Instead, ARCC is trading at a slight 2% premium and is cheaper than it was this time last year.
All I can say is thank you for the dividends as I pick up more ARCC.
The ARCC publishes its results on the morning of July 26th.
Choice #2: RNP – Yield 7.2%
Do you know what I love most about bear markets? Investors tend to sell everything. The good, the bad, the ugly and the profitable tend to be lumped together when investors rush to cash in.
Cohen & Steers REIT & Preferred Income Fund (RNP), is an example of a great investment that the market has pushed aside in its rush to cash. RNP is a fund that invests in some of the highest quality real estate investment trusts (“REITs”). Their Top 10 is a “who’s who” of blue chip REITs. (Source: RNP Fact Sheet)
The market is selling REITs as if they were toxic, likely due to rising interest rates. Yet these companies find themselves in a fantastic earnings environment, as rents have risen with inflation, while they benefit from the tailwinds of having refinanced at historically low interest rates.
REITs benefit from rising rents while having relatively fixed expenses. The biggest expense for most REITs is the interest on their debt. However, over the past two years, REITs have refinanced as much debt as they could at historically low rates. Refinancing often over more than 10 years. Few REITs have significant debt maturing before 2024, so they benefit immediately from increased revenues, but it will be several years before rising interest rates drive up expenses. REIT earnings generally surprised the market in Q1, and as Q2 begins, we expect the market to be even more “surprised” by the strength of REIT fundamentals.
It had been a long time since inflation had been this high. Wall Street is used to looking at REITs in a low inflation environment and fails to understand the real benefits of owning in an inflationary environment.
In addition to an excellent portfolio of REITs, RNP also has a significant allocation to preferred shares
Preferred shares also faced headwinds as fears of Fed rate hikes dominated the world. They are significantly oversold and this part of the portfolio is likely priced higher as well.
With RNP, we have a solid return of 7.2% and plenty of room for capital appreciation in the second half. When the market is scared, I’m happy to find quality payers and collect my distributions until the market comes back.
By using RNP and ARCC, we can turn a Pyrrhic victory into a real victory. We can approach the battlefield of life with a growing and steady supply of income knowing that our original capital is working hard to earn more.
Unlike cash, we don’t beat the market, while simultaneously losing.
Retirement shouldn’t be a time to lose by winning. You will be able to enjoy victory without knowing that the next battle will be the last.
Instead, have constant reinforcements flowing into your account. This army of dollar bills will help you win the war against rising prices and the escalating cost of living. You can enjoy continued financial freedom and independence without being weighed down by debts and bills you can’t pay.
Live victoriously. Live in the light of financial freedom.
Achieve this goal through income investing. You can do it. I shoot for you.