Investor Letter
For the first quarter of 2023 the TRC total return strategy returned 2.3%* despite extreme turbulence in the treasury and bond markets.
* The TRC actual performance data was established on August 13, 2020, with a $2.2 million IRA utilizing the TRC Total Return Strategy for an account at Charles Schwab & Co. compared to various fixed-income benchmarks. The TRC total return strategy combines eleven sleeves of income production described in previous letters. This total return had the benefit of many NAV discounts for the 11 Closed-end fund sleeves when initially entered plus generally lower valuations which may not be the case going forward. Moreover, these returns were gross returns (before fees), had most of the closed-end funds reinvesting monthly dividends, required active management and rotation amongst the eleven sleeves with occasional concentration up to 50% in any distinct sleeve (like the high-dividend equity sleeve, probably the riskiest) with this concentration offset by diversification within that concentrated sleeve. There is no guarantee that similar returns will be made in the future.
The overriding investment mantra for TRC remains: Find the best risk-adjusted income-producing securities based upon research and experience that seek to achieve a total return of 6% - 10% annually over a full economic cycle (depending on risk profile).
Rather than dwell on the past, let’s focus on how to make conservative “realistic” returns this year and next. Unfortunately, the period of easy 15% - 20% annual equity returns of the last 20 years spurred on by a prolonged low-interest rate environment is over and now the Federal Reserve is willing to risk a recession to combat inflation.
The major issues facing both the equity and debt markets are the following (I will give TRC’s portfolio strategy for each thereafter):
1) The Banking Crisis (Silicon Valley Bank, Credit Suisse, First Republic, Signature Bank)
Over the last few months, I attended webinars by large reputable investment firms all suggesting banks have no choice but to tighten lending standards and require more collateral to make loans.
Most economists therefore predict a recession to occur sometime this year which would negatively impact stocks because stocks, in general, require earnings growth to appreciate.
TRC Solution: Buy short-term treasuries backed by the full faith and credit of the US Government – TRC has been buying short-term treasuries yielding 5+%. Rates this high with theoretically no risk are compelling; the current budget battle between Republicans and Democrats poses some risk but likely not to result in a default. The last time there was the level of brinkmanship anticipated in Congress was in 2012 when the stock market went down 12% in a flash, but U.S. treasuries went up in a “flight to safety”.
Treasuries at 5% present an attractive risk-adjusted return in the current market environment and TRC is taking advantage of these safe high yields. As the core of our income-focused strategy for 2023, TRC is increasing allocations to 15% - 20% from approximately 10% for most clients. TRC’s overall goal is to achieve a 6% - 10% total annual return largely through income from bonds, corporate loans, bank-preferred stocks, municipal bonds, and other debt-backed securities.
2) Inflaton and the Federal Reserve:
What has caused all this market “sturm and drang” is the fact that the Federal Reserve printed too much money and then the Government made financial assistance readily available to combat the economic decline linked to Covid. Now the Fed is moving rates higher to quell demand for goods and services and even allow for a recession to bring 5% inflation down to their stated goal of 2%. Unfortunately, inflation is sticky and does not go down as fast as it goes up – hence the problem will be with us for a while. Meanwhile, the stock market forecasts interest rate declines of 200 basis points by the end of the year – in other words, the stock market is playing a game of chicken with the Fed basically saying we don’t believe that you will keep rates high and possibly force a recession.
TRC Solution: Own gold as a hedge against inflation, which we are doing strategically through GGN (a closed-end fund which owns the biggest gold stocks and sell calls against them monthly to pay out over 10% annually, with consistent regular monthly distributions).
Another strategy is to own investment-grade bonds through ETFs because they are low-cost and less volatile than closed-end funds. TRC has rid of those closed-end bond funds that are not earning their high distributions (8% - 12+% annual returns paid monthly) and is concentrang on those that do with a long-term track record.
3) Fears of Recession – real or paranoia?
With the S&P 500 trading at 19x forward earnings and nearly 20x trailing earnings (near historical highs) — estimates based on the last 12 months of a company’s earnings — stocks in general appear expensive given the risk of recession relative to bonds and the high yields available today.
TRC Solution: TRC’s focus is on the benefits of owning U.S. treasuries, higher-rated bonds, corporate loans, and other income strategies because when interest rates go down debt prices tend to increase.
4) Macro International Headwinds and concerns: Russia vs Ukraine, China, Middle East, Korea:
The stock market has largely ignored the risks linked to these macro issues but maybe they should be taken more seriously.
TRC Solution: TRC clients are somewhat protected by owning U.S. treasuries, bonds and gold which tend to be purchased as a defensive hedge against turmoil and disaster.
TRC Strategy – Total Return Portfolio Construction:
This blend or “barbell” approach could achieve a 6% -10% return from income distributions alone.
If the NAV discounts (many closed-end bond funds are currently trading with a 10% -15% NAV discount) go away and the market “normalizes” like it did 2-3 years ago, TRC’s Total Return strategy could provide a total return of 10% - 12+% which is equal or above the long-run average for the stock market with more downside protection in bankruptcy or distress than stocks given its senior status in a corporate structure.
Moreover, Moody’s has noted that over the last 30-40 years, recovery rates in bankruptcy for corporate senior secured loans averaged $0.60 - $0.70 on the dollar, or $0.30 - $0.40 on the dollar for unsecured bonds. Stocks can lose all value as evidenced by Silicon Valley Bank and Signature Bank (two stocks that were considered safe and predictable) or retailers like Bed Bath and Beyond where the stock again has become worthless in bankruptcy.
This is a lot to digest, but it is important to share details of the strategy being employed based on 30 years of bond research and experience. If the economy and the stock market stabilize, TRC will add value stocks with large dividends or the ability to make large dividends.
Let’s talk about the above; I welcome the opportunity to go into more detail or provide more examples.
Best,
Sebastian