Take This Ultimate Game Plan for a Higher Private-Equity Income

Last week Henry McVey of private equity giant KKR & Co. (KKR) put out a piece titled “The Uncomfortable Truth” describing his macro view of the world and the global search for yield.

He makes the case that due to a few crucial factors like a slowing economy, aging population, excess capacity in many materials, and expanding technological innovation, that interest rates in the developed world are likely to remain low for a very long time.

While I would like to argue that he is wrong, I simply don’t think I can.

We saw in December how violently markets reacted to attempts to normalize interest rates.

It would seem that the central banks of the world have gotten themselves into something of a pickle, and they won’t find their way out for quite some time.

I read pretty much everything Mr. McVey writes for two reasons.

First, he is laying out the macro game plan of a firm with $200 billion in assets and fingers in just about every corner of the global economy is going to follow.

Second, I have been following him for several years now, and he is right far more often than he has been off the mark.

Following his macro view has made me money, and I am willing to listen to anyone that can help me make more money for myself and Max Wealth readers.

Hedge the Top ETF with This Game Plan

In this latest piece, he outlines a game plan for income-oriented investors to follow in a world where yields are low and likely to stay that way for a very long time.

He uses a barbell approach of short-term government bonds and long-dated real assets to capture income streams well above that available in fixed-income markets alone.

Fortunately, I can take his advice and use closed-end funds, REITs, and even the unusual step of including an exchange-traded fund (ETF) to help you turn your income portfolio into a high powered private equity-like portfolio.

Using this strategy in particular gives you not only a higher income but also long-term capital gains to help your net worth grow as you cash checks every month to enjoy the rest of your life.

Until you take advantage of that opportunity, KKR’s macro head suggests that we put some of our cash into short duration U.S. government bonds.

While yields are low, historically U.S. government debt pays the highest yield in the developed world.

Many nations in Europe and Asia still have negative interest rates as they try to jump start their frozen economies making even the low payout of U.S. govies seem gargantuan in comparison.

I am not usually a big fan of exchange-traded funds, but the iShares 1-3 Year Treasury Bond ETF (SHY) is the most efficient way to gain exposure to short-term treasuries right now.

Treasuries are liquid enough that I am not too concerned about the sell to who factor that could disrupt junk bond or equity ETFs, so I can get comfortable with this particular fund.

At the current price, the shares yield about 2.23%.

I am going to hedge that with the Western Asset Inflation-Linked Opportunities & Income (WIW) closed-end fund.

This fund buys Treasury Inflation-Protected Securities (TIPS) and has an average weighted time to maturity of right around five years.

Since no one on the planet thinks we will ever see inflation again, we can buy the fund at a discount of $13.61 right now and capture a yield of right around 4%.

Just in case everyone on the planet is wrong, this gives short-term government bonds that will explode upward in an inflationary environment.

The strategist also wants to own short-term housing loans in the United States.

Once again we will turn towards the closed-end fund market place and buy the Brookfield Real Assets Income Fund (RA).

The funds invest primarily in housing-related debt securities and right now has a duration of just 1.61 years.

We are getting the shares at a discount of more than 6% and gaining a yield of over 10% at the current price.

Moving onto longer dated real assets, Mr. McVey wants us to own income producing assets in last-mile fiber assets, mid-stream energy assets, cell tower assets, renewable energy, and power, water, and utility assets.

Once again we can use the heavily discounted closed-end fund to buy these assets at bargain prices and capture above-average income streams.

You Get Paid More with Only a Few Key Exposures

For utility exposure, we can buy The Gabelli Global Utility & Income Trust (GLU).

We are buying shares at a discount of over 8%, and the yield is currently above 6.5% right now.

You get gas, electric, cable, and water exposure at a bargain price with Mario Gabelli, one of the best fund managers on the planet, overseeing the portfolio.

For cell tower exposure we will add some shares of Crown Castle International Corp. (CCI).

The REIT owns 40,000 cell towers and approximately 70,000 route miles of fiber in the United States.

CEO Martin Landis is a big believer in the future of the business as he just bought over $2 million worth of his stock.

We gain 5G exposure and enjoy a yield of around 3.6%.

Midstream energy assets are things like transportation, pipelines, and storage of energy products.

We can make one purchase to get an excellent portfolio of these assets at a discounted price.

The Kayne Anderson Midstream/Energy Fund (KMF) owns an outstanding collection of midstream assets and is trading at a discount of 12% to the value of the assets they own.

At current price the yield is almost 8%.

Now KKR wants to add exposure to opportunistic credit.

Mr. McVey notes in his report that “However, the most practical application of our world view of heightened volatility is our sizeable allocation to Opportunistic Credit which has maximum ability to invest across High Yield, Loans, and Structured Products. We also think it makes sense in the lower return, wider dispersion environment that we are envisioning.”

This one is easy.

The Apollo Tactical Income Fund (AIF) is in the opportunistic credit business and invests in different types of credit instruments including senior, structured loans, and high yield corporate bonds.

The fund is managed by one of the largest private-equity and alternative asset managers in the world today, Apollo Global Management (APO).

The fund trades at a 12% discount to net asset value and yields 8.25% right now.

Now the Final Plays in Real Estate

Now we want to own some real estate related assets.

KKR specifically likes U.S. multifamily logistics and distribution centers, in addition to senior living and healthcare facilities.

We can get all the logistics and healthcare portions of that with our favorite battered REIT, Colony Capital (CLNY).

As a bonus, we get additional digital real estate access as well as more real estate credit.

We are paying about half the asset value of the properties they own and will enjoy a yield of 8.7%.

For multifamily, McVey suggests we favor second-tier cities in the U.S.

The population shift from major population cities to smaller cities to gain a more affordable and enjoyable life is something I have talked about often.

We can get the exposure to this by buying shares of Independence Realty Trust (IRT).

The REIT owns eight multifamily apartment properties, totaling 15,880 units across non-gateway U.S. markets, including Atlanta, Louisville, Memphis, and Raleigh.

This addition to our income portfolio is yielding 6.82% right now.

Finally, we want to own commercial real estate loans.

The easy way to do this is to shares of Ares Commercial Real Estate Corporation (ACRE).

This REIT makes loans on commercial real estate across the United States and is managed by one of the leading credit and private-equity investors in the country, Ares Management (ARES).

This REIT is yielding 8.91% today, and the portfolio is more than 90% floating rate loans adding in an additional layer of protection against a surprising upward move in interest rates.

An evenly distributed allocation across all ten assets gives us a yield of roughly 6.7%, or more than 2.5 times the 10-year Treasury bond yield right now.

You also have considerable upside potential form assets that will benefit from the low-interest rate environment keeping GDP growth positive.

In case the push works a little too well, and we see rates move higher than anticipated we have some hedge against that with floating rate mortgages and treasury inflation-protected securities.

We also have the potential for rising income streams form our REITs and closed-end funds as well.

No portfolio is perfect but if you are looking for an income portfolio that uses the private-equity mindset to achieve your goals and protect your money this one comes pretty damn close.

To the Max,

Tim Melvin

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