Ken Kam's Best Ideas Blog

When I was in college, Paul Volcker, who was then the Chairman of the Federal Reserve, pushed money market interest rates up to around 13%. I remember thinking that if you could lock up that kind of return why would anyone bother with stocks.

After all, the long-run return of the S&P 500 is about 11%. But stocks don’t deliver 11% every year. As we’ve seen, they can go for long stretches of time with lower and even negative returns.

If I could lock in a rate of return above 11% I know I would sleep better at night.

Money market accounts are nothing to get excited about right now. But the commercial paper market is having a fire sale and the yields have soared.

Take the Managed High Yield Plus Fund (HYF) for example. This is a closed end bond fund that invests in a diversified portfolio of commercial paper. On Tuesday it closed at $1.56 per share. The fund pays a monthly dividend that works out to $0.48 per year – an annual yield of over 30%!

What’s the catch? The bonds are not of the highest quality so there is risk that some will default. But the bonds are already trading at a big discount to reflect this risk and it would take a lot of defaults to bring your overall yield below 11%.

If the market gets worse, I’ll be happy to hold on for the 30% yield. If the market gets better, the yield should come down and the price should rise.

A month ago the yield was just under 20% and the price was about $2.50. This means that if commercial paper market eased enough to bring the yield back to 20%, these shares could go back to $2.50 for a potential 57% gain.

If the Federal Reserve’s plan to buy commercial paper succeeds in restarting this important part of the credit market, HYF could be a big beneficiary.

Chris Rees, the mFOLIO Master who brought this stock to my attention, had this to say about HYF.

“In times like this, it is natural for people to experience fear and contemplate safety. However, it is my belief, especially right now, that the safety investors may
be seeking, may not be found in a money market fund making 3%. A couple of MM funds recently broke the dollar peg, one losing 10% of its value. And that's cash!  I'd rather be invested in hard tangible assets purchased at a healthy discount and producing good income than be sitting in cash. And it's important to note these returns are not just while the crisis is on, but for years to come.”

In addition to HYF, Chris has found 2 other stocks with similar characteristics. We are buying all three of them for our managed account clients who are mirroring Chris Rees’ mFOLIO.

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Posted by Ken Kam at 3:13 PM | Permalink