Anthony Speciale Stock Market Analyst

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Two Picks That Pay You More as Inflation Rises

Let’s talk a bit about interest rates today, as in the last couple of weeks we have seen rates begin to rise. Fears of the omicron virus are still with us but there’s no longer the fear that it’s going to crush the global economy in the way that we originally thought it might.

Inflation is continuing to run at an absolutely unchecked level, with the highest level of price inflation that we’ve seen in about 40 years.

When this all started, I said that letting the inflation dragon out of the cage was a dangerous task and that the last Fed Chairman that tried it ended up heating the economy up and couldn’t get inflation back in the bag for a very long time.

Now, is that going to happen again? I don’t think so. Right now, the interest rates markets are telling us very clearly that inflation is here, it’s not going away and it sure isn’t transitory. We’ll probably be into 2023 before we get some handle on controlling price inflation.

By then, we should have some of these supply chain issues well in hand, and the markets will be functioning a bit more normally.

And because the Fed is accelerating the taper of their bond purchasing and may raise interest rates a lot quicker than we want to see in 2022, that could get inflation back under control. But it could also kick us into a mild recession. We’ll see how it plays out.

Rates are going to move up a little higher, but they’re not going to go up fast enough to do any good at all for those of us looking to invest for income from our portfolios.

So, if you’re getting close to retirement or depending on earning income to fund the retirement that you’re currently trying to enjoy, you probably have a problem because it’s just not going to get better any time soon.

When I look at what’s going on in the markets right now on the income side, the 30-year is at 1.85%, the 10-year is at about 1.45%, which is not enough to finance a retirement. A 30-year bond at less than 2%… When I started doing this, the 30-year was yielding around 8%.

If you had six figures and put it in the bank 8% could make a difference to your retirement. 1.85% is really not going to do much for you at all. Now, Wall Street will tell you that they have products that will raise income but it’s their income that they’re really raising and at your cost. So, Wall Street doesn’t have the solution.

Looking at blue-chip stocks trading at 25 times earnings with a 3% dividend, I don’t think that’s going to give you much of a solution either. And bank products are based on what Treasurys are yielding, so they’re every bit as low as Treasury returns and just won’t get you where you need to go.

But let’s look at a couple things that might help you get you where you need to be when it comes to having income flowing from your investments.

Apollo Tactical Income Fund Inc.

I’m a huge fan of Apollo Tactical Income Fund Inc. (AIF). This fund allocates money between senior bank loans that trade with floating rates and high-yield bonds at the manager’s discretion.

Right now, the fund is almost entirely in those floating-rate senior loans because interest rates are going to go up and you’d like to have the extra security of being in a senior loan that’s way up in the capital structure, so you’ll have far less problems if there are financial difficulties.

The fund is managed by one of the world’s largest alternative asset managers that is an expert at both borrowing and lending money and has a really great track record in the alternative credit space. Rates go up, so do the payments we receive from the fund.

If they don’t go up, we’re buying a fund at 93 cents on the dollar of the value of the loans in the portfolio, and we’re earnings over 7% on our money. There are not too many alternatives that are going to give us a relatively safe 7% that also has some inflation-proofing built right into the asset mix.

This is a fantastic addition to an alternative investment portfolio, as it not only provides income but inflation-proofing as well.

KKR Real Estate Finance Trust Inc.

Next up is KKR Real Estate Finance Trust Inc. (KREF). The price has fallen to a nice entry point, mostly because they did a stock offering to raise some money to put to work in new opportunities. It sold off a bit because of the offering.

This fund originates, purchases and trades in commercial real estate loans. About 99% of these loans are senior loans, so if something goes wrong, you get paid back first, and they’re 99% floating-rate, which means a nice level of inflation protection. If rates go up, so will the payments from this fund.

Almost 70% of the portfolio is in office properties and multi-family properties. They have a growing life sciences business, a bit in campus housing and they cut back their exposure to hospitality lending. So, it’s a well-diversified portfolio both in the type of business, and it’s diversified across the United States in the strongest commercial real estate markets.

Remember that KKR is one of the largest real estate buyers and lenders in the world today, so they know where the action is, and that’s where they’re lending money. These tend to be shorter-term loans just a few years out, so they’re not taking on a full 30-year mortgage on commercial real estate buildings. Most of these will be transitional, transactional or bridge loans.

It’s a quality loan portfolio, as KKR is one of the best alternative asset managers in the world today right up there with Apollo. They can draw on all of their expertise and contacts when it comes to sourcing and funding loans.

It’s got inflation protection built in, an 8.1% yield and is trading at about 95 cents on the dollar of all the loans in the portfolio. Again, this is a solid high-yield addition, yielding about five or six times what you can get from banks or Treasurys, with a high level of safety. I think commercial real estate markets are going to be fine in 2022, with a growing economy.

So, an 8% yield and inflation protection… Add it to a portfolio of alternative income assets, and that can help you get closer to realizing the cash flow from your investments that you need to make your retirement all you dreamed it could be.