Income-ing
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The latest in an infrequently produced series on income investing by Inner Circle member 1markb44
A quick look at any FinX poster will make it clear that there is no shortage of foolproof ways to make a surprising amount of money in a short time. Of course, “surprising” can work in more than one way—someone can find, to their surprise, that what remains is a lot less than what they started with. As Alex pointed out just recently, leveraged single-stock funds, anyone? Great on the way up, a very tricky set of beasts on the way down.
One thing that strikes me about many investing methods, even the good ones, is how much work they entail when using. Another thing is how much work they take to simply learn. I read in-depth explanations of Elliot Waves or options trading and, speaking personally, my head spins. We have many gifted investors in the Cestrian services, and I’m not one of them! And since I know that if one doesn’t really understand an investing method one is better off not using it, I try to keep things on a more simple basis in my own investing. This has led me over time to use fixed income more and more.
Part of this is due to my age and economic situation. Thanks to being in the middle of the Boomer cohort and the government always trying to do as much as possible for the older generations at the expense of future ones, not to mention staying married to the same person (divorce being VERY expensive--just ask my father, who got married three times and ended up crossing the finish line about broke), I’m at the stage where I can afford to play defense. Offense is the province of the young, when one has personal capital to burn and decades to accumulate wealth and recover from mistakes.
The other part is pure laziness. I don’t want to sit at my screen and mange market fluctuations. I don’t want to put the work into mastering techniques. And these days when I read about the Latest Thing that, if we all get into soon enough, will make us all rich, I just get tired. So, as I said, I do a lot with BDCs and other fixed-income instruments, and stay relaxed in my investing.
Howard Marks, who is the head of Oaktree Investing and a legend in fixed income, made some interesting points in one of his quarterly letters recently. First, for all those who automatically think “junk” (more politely known as high-yield) bonds are much riskier than the stock from the same company, remember that bonds get paid back before equity 100% of the time. The junk bonds aren’t just issued in a vacuum; there’s a company behind them that uses the bonds’ proceeds to fund operations. So for the company to default on the junk bond it would be going bankrupt. In those rare situations bondholders typically, according to Marks, claw back 33% of the bonds’ value; equity holders typically get nothing, as they’re last in line. Which makes one wonder why buying small and mid-cap stocks, which are the companies usually issuing high-yield bonds, is “safer” than just buying the bonds themselves?
The second point Marks made was that looking back over 40 years of high-yield behavior the median default rate for high yield was 2.7%, and it was even better if you took out the two two-year outlier periods of 1990-1991 and 2000-2001. But even taking the 2.7% figure, if you are paid back the 33% of the bonds’ values then all you need for high-yield to make sense is for the spread between a risk-free Treasury bond and high-yield bonds to be more than around 2%, not a very challenging goal. In other words, if a T-bill pays you 5% then any bond that pays you 7.5% or more is more than compensating for the risk involved.
Currently there are a host of BDCs paying 10% yields (a BDC is just a sleeve of loans to small companies, so why not think of them as bond funds?), and any number of CLO bond funds that mostly hold tranches of bonds and other income instruments at all levels of the bond universe, from virtually risk-free AAA bonds to CLO equity sleeves, the riskiest level and thus highest yielding. Both BDCs and CLOs use leverage to magnify yield, and of course risk as well—that’s what leverage does, magnify things both good and bad. A CLO holding just AAA bonds will pay 5-6%, one holding equity with lots of leverage will pay around 20% (looking at you, OXLC, and it even uses its own capital to juice the distribution, so the NAV is in a constant downward state—not for me, thank you). I tend to use ones that take a balanced approach and thus pay 10-14%.
For CLOs I currently hold ARDC, from the same investment house that runs ARCC, the biggest BDC; EIC, which is a milder version of the better-known ECC (another one that resembles OXLC), PHK, from the huge Pimco bond house, and XFLT, from Octagon. Yields range from 10% to 15%.
All reduced their dividends recently, which caused their share prices to dip. I would much rather have my bond fund managers adjust the dividend to reflect reality (in this case, the Fed dropping interest rates) than eat the NAV to pay out too much, so I loaded up on all four funds after the drops, as the lower prices keep the reduced dividends at an attractive yield.
My BDC sleeve is currently made up of ARCC, BXSL, GBDC, OBDC, CGBD and TRIN. Yields range from 8.5% to 14%. In general I’m going with the biggest and safest BDCs, with low non-accruals, at this point with so much uncertainty in the economy.
I have one mREIT, DX, which holds agency mortgages, so mostly residential and backed by Fannie and Freddie—in theory the safest kind—which pays 16%.
A new group to me, but very interesting, are the funds that buy parts of the market and write calls against their stocks, or the market itself, to produce a good yield that they pay out monthly. Funds like JEPI and JEPQ have become hugely popular. I hold QQQI and GPIQ, which both write calls on NASDAQ. Each pays around 10%. So essentially I own a slug of the usual Mag 7 suspects with the upside somewhat limited, and in return I get paid the dividend monthly.
If you’re looking for international exposure, which may be a good idea with US stocks at higher multiples than international peers, the BlackRock fund BGY does the same trick—hold a global sleeve of stocks and write calls against them to provide a 9% yield currently.
This is a diverse group in name, but may very well react very similarly if stressed. I’ll find out at some point. But the key for all income-producing vehicles is simply that—can they continue to spin a good yield? If they can then the share price is a secondary concern. ARCC lost half its share price during 2020’s Covid crisis, but never changed its dividend (so for a while was yielding an eye-popping percentage, of course), and over the following year clawed its way back to the normal share price. All one had to do during the paper loss of 50% of its “value” was to ignore the price and watch the dividend. What I learned is that it’s a lot easier to see one’s stock drop 50% when it’s paying you to patiently wait!
Income investing may not be as exciting as finding the Next Big Thing, but it has its attractions—sitting back and watching money come in monthly or quarterly works for me! And with the markets at, shall we say, aggressive levels currently it may be in all investors’ interest to park some funds in vehicles that pay one to wait while the market goes through its drama.
Thanks for reading!
1markb44, 15 July 2025.