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Why 2022 Could be a Very Interesting Year…

Hi guys! Tim Melvin here, and welcome once again to A Better Way to Wealth!

It’s still really early in 2022 and, as we’re looking forward, this has all the makings of what could be a very interesting year.

The Federal Reserve is clearly positioning itself to accelerate the end of bond purchases, and if we continue to see decent employment reports and jobs numbers, we could see the first of what may be as many as three or even four interest rate hikes as early as March!

Now, this is going to make it really difficult for those of us out there looking around for income-producing investments.

Rates are starting at such a low place that even if they raise them four times, we’re only going to be between 1.0% or 1.25% on the discount rate, and that might take the 10-year Treasury up around 2.25%, maybe if it’s really aggressive 2.5%.

We can’t do much with that as income-oriented investments investors, but each little incremental bump up in interest rates does make our existing fixed-income investments a little less expensive, and we could actually see the price go down a little bit.

So, we’ve got to negotiate some very tricky waters since we don’t know what’s going to happen with inflation, which is also a big factor in income-oriented investing valuations.

As you can see, we’re stepping in some dangerous, if not treacherous, waters here in early 2022 if we’re looking to put new money to work.

So, let me jump in here and throw out some ideas that I like here in early 2022 that not only have really strong yields, but have a certain measure of inflation and higher interest rate protection built into the investments.

Owl Rock Capital Corp.

The first one up is Owl Rock Capital Corp. (ORCC).

This is a business development company that lends to the top end of the middle market segment of US industries, looking for the companies with closer to $50 million of cash flow than $10 million or less of free cash flow like some other BDCs.

They also like to work with the top private equity firms and have a huge network of private equity firms who need to borrow money for the companies in their portfolios to conduct the buyout of the company itself or to expand the business.

Whatever the reason is, they’re going to come to Owl Rock, and they will help them finance the project. 

But these guys are really tough… They’re only lending to people that can pay them back. 

They’re one of the few business development companies that I’ve run across that’s super aggressive about putting covenants into the loans that prevent companies from spending money in a certain way, buying back shares if they happen to be a public company and no distributions or dividends to the founders or current partners. 

None of that’s going to go on here. Cash flow goes first to the loans because most of their loans are senior loans.

They are also mostly about 99% floating rate loans, meaning if interest rates go up, so will the payments on the existing loans in the portfolio!

It’s a nice portfolio with 130 companies spread across 27 different industries. They’re looking for recession-proof businesses with software being one of the leading industries in the group as well as health care, which is also well represented.

Again, these are companies that are not going to see their cash flows disappear should interest rate markets (and my readings) be absolutely correct, leading to an economic slowdown or even a recession sometime in 2023.

So, we’ve got protection against higher rates, and you’ve got industries that are more resistant to recession so the loan portfolio should be in pretty good shape. 92% of the loans in the portfolio are senior secured loans, which get paid first.

The only people in front of them are the bank and the Internal Revenue Service who would get paid first if something goes wrong, but not much tends to go wrong with their companies. 

They have a default rate, of all the billions of dollars that they’ve lent out over the years since the IPO, of just 0.14%. 

Remember, these guys are very strict, very conservative and very good at what they do, and the shares are going to pay you right around 8%, which is something that’s really hard to find under current market conditions.

So, you’ve got this portfolio of very conservative loans with strict covenants to make sure that we get paid back first, you’ve got recession resistant industries, an 8% yield and protection against higher interest rates because 99% of the notes are floating rate.

FS KKR Capital Corp.

Next up, I’ve decided to bring out an old favorite. I absolutely love this business development company and, if you don’t already own this one, I highly recommend them.

Guys, I’m talking about FS KKR Capital Corp. (FSK).

FSK is the second-largest BDC in the country after a merger last year that combined two smaller BDCs that the two companies were co-managing. 

Currently, they’re trading at about 80% of net asset value with extremely low leverage levels compared to the rest of the industry.

They do have a variable dividend, so if you look at the quotes you know on the various services it looks like a 12% dividend because they’re taking the most recent payment, which may or may not end up being where the yield is…

The target rate is 90%, but they’ve been outperforming that. Currently sitting at a 12% annualized rate, I’m still expecting it to bounce around a little bit, but I think you’re going to average right about 10% dividend yield.

So, you’ve got the possibility of some upside as it trades up closer to net asset value, and it’s got what should be about a 10% dividend.

I love being able to affiliate with a large private equity company and a large alternative investment firm like KKR and FS Investments. These guys know this private credit space better than anybody else on the planet, in my opinion.

You get 73% senior secured loans, and you get 90% floating rate loans, meaning inflation protection.

Again, they also tend to look to do business with companies that are somewhat recession proof, with software and healthcare playing a big role in that.

And when evaluating loans, they have access to all of KKR’s resources, both in private equity and private credit, and I think that gives them a huge advantage over the many other business development companies in the field.

Again, they are at a 10% yield which is very attractive!

Saba Closed-End Funds ETF

Finally, we come to an exchange traded fund known as Saba Closed-End Funds ETF (CEFS). 

Now, I don’t usually recommend exchange traded funds because I think you can do a little bit better with individual securities, but this is the one area in which I’m going to make an exception.

Now, I’ve told you guys the story of Saba Capital several times now so you should know that Boaz Weinstein, in my opinion, is the single best income-oriented investor on planet Earth at this moment.

This guy has produced phenomenal results, and he’s pointed out that the biggest anomaly in the US markets is closed-end funds trading at a discount – and there’s lots of them!

Weinstein has basically become the new sheriff in the closed-end space…

He will buy big positions in closed end funds and lean on management to do whatever it takes to close that discount, whether that’s a tender offer, a buyback, a conversion to an ETF or regular mutual fund, or just a liquidation and a return of the cash, he’s not shy and will really lean on these fund managers when force is needed.

He’s pushed several such managers to do all sorts of transactions in the past to help narrow discounts and cash in some big profits, and we’re going to let him do the same thing for us here.

Now, here’s what’s cool about this right now… 33% of the CEFS fund is currently invested in five-year Treasury bonds, so short-term and ultra safe, that can be liquidated and moved into other opportunities.

37% is invested in floating rate, closed-end funds that will see their rates go higher if we get inflation, which drives interest rates higher here in the United States.

So, as you can see, a big safety component, a big inflation protection component and then a lot of it’s put into closed-end funds where he is actively waging an activist campaign and trying to force discounts closed.

Like I said, that will add lots of profits and cash flows that will come back to us in the form of dividends and capital gains to what was already a very attractive yield of 7.92% as of this recording.

This is just a great investment that you can buy, tuck away and let Boaz Weinstein and his team continue to produce high levels of income that will be paid out on a regular basis and provide you with upside potential by forcing closure of some closed-end fund discounts.

So, there’s my three best ideas for this moment in time in 2022 to help build a portfolio of alternative income investments that produce the cash flow that you need to live the life you want.