I haven’t written much, if at all, about Richard Band over the years, but he’s certainly a been a fixture in the investment newsletter landscape for quite a long time (I think the letters been running for 30 years or so) … so when I saw his latest teaser pitch I thought I oughtta give it a look for you.
Band’s Profitable Investing is fairly typical fare in the business — a monthly newsletter with commentary, some stock and fund picks and a few recommended portfolios. He says that he’s the expert on “low-risk growth,” and Hulbert’s recent analysis of “honor roll” newsletters tells us that his portfolio performance has generally been above average in bear markets and below average in bull markets (he didn’t make the honor roll, just to be clear — you have to be above average in both kinds of markets for that). Here at Stock Gumshoe we’ve only had a few reviews submitted on this particular letter so far, you can see them here if you like.
So what, then, is he teasing for us in his pitch for “Consistency in an Unstable World?” Let’s check it out.
The big promise is that you can “Collect a $8,000 payday every three months” — which sounds pretty good.
He also says you have to act before September 15 to grab your first check, so I have to apologize for being a bit behind on my mail. I throw myself on the mercy of the court, and hope that if you like this one you’ll be willing to wait a few months for the next “payday.”
Some more details:
“I just uncovered the one investment that could single-handedly help you beat inflation and provide you with a larger income stream than you ever thought possible.
“My new favorite income fund pays an 80-cent dividend each quarter, or a whopping 20% annually. Putting that into perspective…
“…You pay less than $20 per share for 10,000 shares, and you will collect $8,000 every quarter.”
Hmmm … notice the marketer-ese in there? Yes, “less than $20 per share for 10,000 shares” sounds a lot better than “invest $200,0000″ to get your $8,000 payday, doesn’t it? And yes, calling something an “income fund” makes it seem more stable and conservative for most folks than calling it a “high-yield stock.” This is, alas, a stock we’re looking at, though it’s a special flavor of stock.
And then we get to the “perfect storm” bit …
“A Perfect Storm
“‘The current economic conditions, the steepness of the yield curve and historically low financing costs continue to provide an outstanding opportunity to invest in securitized mortgage assets.’”
“I couldn’t agree with our income fund’s president and CEO more.
“You see, home prices are still in the toilet, and the rental market is heating up. But who wants to be a landlord? Not me. I prefer hammocks over hammers, and well-managed mortgage funds over real estate.
“Enter my favorite income fund.
“It’s a mortgage real estate investment trust, or REIT, that invests in mortgage-backed securities. I’m talking residential mortgage-backed securities guaranteed by the U.S. government, commercial mortgage-backed securities, and residential and commercial mortgage loans.”
So yes, he does get down to clarifying that his “income fund” is a mortgage REIT, which are sometimes referred to as MREITs — these are stocks we’ve talked about in this space many times before, and they really do act like a form of investment fund. They essentially just raise equity, lever up that equity with (sometimes a lot) of short-term debt, and use that pile of capital to buy and manage a portfolio of mortgages.
The most well-known of these are the giants like Annaly Capital Management (NLY), which buys mostly federally insured mortgages, but there are several other good-sized companies in the business, most with slightly different variations (ie, some buy commercial mortgages, some focus on adjustable rates, some buy only government-backed paper, some borrow more than others, etc.) and different performance, and a bunch of startups who have tried to seize the day in recent years and profit from low short-term interest rates.
So which one is Band teasing here? Well we can toss those few tidbits he provides into the ol’ Thinkolator, and after just a wee bit of chewing we learn that our MREIT here is … Invesco Mortgage Capital (IVR)
IVR is one of the MREIT’s that has a higher perceived risk among investors, which is why it carries a dividend yield of about 20% right now, substantially higher than the somewhat more conservative companies in the space like Annaly or Capstead Mortgage. IVR can buy into things that some MREITs can’t, like commercial mortgages and non-federally guaranteed mortgages, so that’s part of the risk, and they are currently borrowing more money, which is the other main indicator of risk.
There are distinctions between all of these companies, and there is certainly the variation in performance that comes from management’s ability to hedge and predict fluctuations in the mortgage market (refinancings and changes in the yield curve are of primary importance), but for the most part you can see that the MREITs that own primarily or only federally guaranteed mortgages (usually called Agency MREITs) or that are levered up 5-7X rather than 8-10X tend to have lower indicated dividend yields.
I don’t know Invesco very well, it’s one of the younger companies (founded in 2008) that has ridden the wave of super-easy capital and federal mortgage largesse that followed the crash in the financial markets — I do know that I’m generally more comfortable with more established names like Annaly since I know they’ve managed their way through very different interest rate environments … they’re dependent on low short-term rates like all of them are, but their management team has lived through an inverted yield curve and, though they stock took a beating, they carry that knowledge and experience with them. To be fair, IVR is externally managed by a big investment firm, Invesco, that’s certainly been around the block — so probably their management team is more seasoned than the 2008 launch date might imply.
The basic business model is the typical bank model: borrow short term at low rates, lend long-term at higher rates, and pocket the difference … and hope that you can perpetually keep renewing those short-term loans and that the gap between short and long remains big enough for a profit.
The many relatively small differences among the different companies obscure the fact that there is abundant fear in the market about these stocks (which is why they have yields between 13-20%, for the most part), and that fear is primarily for the whole business model, not just for a particular sub-strategy or management team. Investors seem to be worried that the yield curve will compress, with short-term rates eventually having to rise a bit and long-term rates continuing to come down — that’s called a flattening of the yield curve, and it generally means that the MREITs make less money.
I don’t personally own any MREITs at the moment, and haven’t for a while, but it is worth noting that the sector tends to attract both high-yield seekers and worrywarts — whenever anything happens with the Federal Reserve or mortgages (and something happens in those areas, news-wise, pretty much every week), there’s at least one pundit who will panic about it and say we’re at the beginning of the end for the great MREIT performance.
That “end” may well come at some point, and when big changes hit companies with huge leverage (like virtually every MREIT) are very vulnerable — and the collapse of some of the players in the industry is still firmly in investors’ memories (just look up Thornburg Mortgage if you want an example of a company in this general sector whose business model can evaporate overnight).
But if you look at a company like Annaly, which is by far the largest stock in the group and the benchmark for the sector, then you can see that absent a couple spikes in performance over the last decade (a peak right before the financial crisis in particular, and a trough during it), you’d have been better off just holding on and collecting your yield of anywhere from 10-20% per year and ignoring the recurring panic about their business model — they’ve ridden through most things, eventually, and paid out a huge amount of cash to patient investors.
Which is a long way of saying that the MREIT’s yield so much because there is a concern about future interest rate fluctuations and/or changes in mortgage policies or rates, but they also yield so much that maybe it’s worth back-benching that concern and taking the risk. Just keep in mind that the potential risk is real — massive changes in government programs, including mass refinancings that could clobber these portfolios, come come any time … and with both short-term rates and mortgage rates at incredible lows the “wiggle room” is limited for finance companies like these, and the temptation is often there for them to use more leverage (borrow more money) and therefore increase risks in order to keep income and payouts high.
I’d personally be more comfortable with the lower yielders and agency MREITs like NLY, but, again, perhaps I’m being too much of a worrier … if I were into taking more risk in this sector, I’d probably look at the beaten down Chimera (CIM), which has Annaly’s management team but a much higher perceived risk because of their lower-quality assets (even though their leverage level is below average).
That’s not to say you should necessarily avoid IVR, I’m sure I know less about them than Richard Band and there’s something to be said for buying one of the highest yields in the group if you think the management team is effective — if the sector tends mostly to move together, why not get more cash in the interim?
There are plenty of other fairly large MREITs out there who’d love to have your investment dollar as well, one of the SeekingAlpha contributors last month listed some of the big ones along with their leverage levels and dividend yields, which might give you a good idea of the breadth of the sector if you’re looking to pick some favorites.
There are also now, in a relatively recent development, a couple ETFs that focus on mortgage REITs if you like the bet on a steep yield curve and the high dividends but don’t want to evaluate leverage ratios or management hedging strategies or choose stocks. The iShares offering, iShares FTSE NAREIT Mort Plus (REM), has been around for a while and currently suffers compared to the sector because it also owns a bunch of small banks with big mortgage portfolios (like Hudson City Bancorp) — thanks to those banks, the trailing yield is only around 10%. The newer offering from Van Eck is the Market Vectors Mortgage REIT Income ETF (MORT), which is much more of a pure play on MREITs and is expected to yield about 14% (it just started, so the first dividend hasn’t really hit yet). Both of those funds, incidentally, cap the concentration of individual REITs they own but they’re still dominated by Annaly shares (NLY is 20-25% of each ETF).
I know there are plenty of folks out there in Gumshoedom who own or have owned these stocks, they’ve long been a favorite of income-focused individual investors, so if you’re in that group and have a story to tell about which mortgate REIT is worth buying or avoiding, I’m sure we’d all love to hear it … just use the friendly little comment box below.