Description

VIC is a place where investors are supposed to share their best ideas, but I haven't been buying much of anything lately other than a few dividend paying stalwarts which I don't think would be appropriate for this board unless something like Campbell Soup is up your alley.  Thus, I'm gong to focus on the one thing I have been buying for a while, and keep in mind as a one-person operation my options are not unlimited.  This is a cousin to the TY- idea posted earlier on this site. 

Introduction

Some investments add “value” not from the absolute level of return they provide but by how the particular security can provide a far superior alternative than other choices.  For those of us who manage money for mom and pops in particular in a non-hedge fund fee schedule these sorts of choices and decisions are extremely important.   By definition, these clients tend to be senior citizens as a rule (age 60+), regularly dip into their portfolios for distributions of all types, and thus the advisor is often forced to embrace a traditional 60/40 or 50/50 stock - bond (cash) allocation. 

There is a lot to like about this approach for most investors - Graham in Intelligent Investor recommended a 25% to 75% stock allocation rule for the Defensive Investor (and most folks fit this category), or 50-50 as defined by Graham in most market environments.  Consider what just happened - in theory, we have just passed out of what he calls 'bargain price levels' and a more to an aggressive posture and using Graham's suggestion to increase exposure would have produced outstanding results.  Conversely, Graham suggested reducing exposure below 50% when the market became 'dangerously high' and because I'm having a hard time finding things I like I feel the market is certainly high.  In essence, Graham recognized the virtue of timing, especially as it relates to settling fear and emotion in most unsophisticated investors like me.   

Fixed Income Side

The problem arises when faced what do with the fixed income side.  Graham covered this, including a discussion of savings bonds, US government debt, state debt, corporate bonds, etc.  Unfortunately, I don't have the time or resources to delve too hard into these areas (many people here do - listen to them!), preferring to magnify the experience and resources I do have on the area where it would make the most bang - the equity side.   What I need on this side for my purposes is something simple and easy to grasp and for that reason I used closed end preferreds. 

Advantages of CEF Preferred stocks

There are basically three advantages with these holdings

1 - they are easy to monitor.  Investigate the CEF itself, look at the asset coverage, and decide if the yield is attractive.  That's it.  Researching these things takes a minimum amount of time, and due to asset coverage rules they are almost interchangeable

2 - for a fixed income investment, the yields are generally very attractive.  Most of the time these investments have returned 5% to 6% as a rule, a solid return for a fixed income like investment (e.g, Vanguard Total Bond Market ETF over the past 10 years returned 3.58% to 8-31)

3 - asset coverage rules provide strong .  The 1940 Act has a safety mechanism which usually results in a liquidation at par of these investments if coverage falls below 200%.  This coverage can be easily measured, and while the get it at par rule isn't fool-proof most responsible fiduciaries will take action to redeem them when coverage is breached.  As an example, in 2008 I owned an auction note for a CEF whose underlying CEF's NAV fell more than 85-90% (run by David Dreman) but the preferred issue was cashed out at par.  Recently, asset coverage below 200% was breached by a Gabelli CEF which resulted in actions by management to restore the coverage.  For this one being written up, here are full details in the prospectus:  https://s3.us-east-2.amazonaws.com/gab-preferred-docs/ggn_b.pdf

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Here are the details for the one I'm writing up - GAMCO Global Gold, Natural Resources & Income Trust, or GGN-B. 

On the CEF itself: 

*735m AUM as of 9-21-20

*top holdings include Barrick Gold, Franco-Nevada, Kirkland Lake Gold, Newmont, Agnico Eagle, Alamos Gold, Newcrest Mining, Chevron, and Exxon.  As the name implies, this is gold and natural resources fund and management is currently leaning more toward gold stocks. 

*as of 6-30, the 5 year annualized return on the CEF is about 6.2% though the 10 year return is actually negative

*the fund pays a regular 3c monthly distribution and other distributions as mandated by the rules of this particular investment (for 2020, total distributions estimated at 48c in 2020, or about 87m in total; 36c would equal 65-70m).  

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Here are details on the preferred:

*size at $25 par value is 86.5m. 

*pays $1.25 a year (4 quarterly installments), or a yield of 5% at par and 4.94% at $25.30.  Recently went ex-divi.

*management does have the option to buy these in the open market, and does sometimes under par ($100m par value orginally issued).  

*the issue is currently callable.  There is always a chance that Gabelli calls this one and tries to replace it with another at a lower rate, but 5% is fairly typical for CEF preferreds and most CEF preferreds that have been called had yields nearer to 6%, not 5%. 

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Asset Coverage

Using current figures, the asset coverage on the preferred is 735/86.5, or 849%.    If it matters, this is currently the highest asset coverage of any Gabelli CEF.   As currently configured, the CEF would need to lose 88% of the value to have a problem with the preferred.  If the NAV fell by 50%, the fund would still have an asset coverage of 425%. 

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Risks

1 - these things act like common stocks during periods of market distress.  Spreads widen significantly and selling liquidity is almost non-existent.  

2 - rising rates - they do show sensitivity to higher rates, but absolute rates are low enough where  it is doubtful there would be a problem unless 10 year treasuries reach 3% and more.  

For someone like me who holds these things, these are the best entry points. 

3 - you don't want about a 5% return over time.  Obvious enough

4 - most suitable for smaller money managers.   They trade, but you have to be careful (this can work to your advantage).  All the CEF p i follow are trading above par.  

That's it - realistically, over time the goal here would be to earn the coupon on the preferred, but tactical timing on selling and buying (for example, around dividend payments) can improve returns, esp. for smaller money managers.  Also, as these CEFs tend to be interchangeable, there are opportunities to increase returns by cross-trading them.  Finally, at times Gabelli throws in unusual wrinkles - like a put option - that effectively converts these prefereds to a fixed rate on the put date.  As noted, it takes a minimal amount of time to monitor them which is the most attractive quality they have.   

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mentioned before, but if you have a family member who is considering single premium deferred annunities or needs a set level of income, these can be a simple alternative, esp. as they don't expire when the family member does 

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my rating - i don't think VIC lets us rate things anymore, but I think this is better than a 2nd grade book report.  If there is a higher level book report, i will give my idea that.  

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