Three BDCs And 3 REITs In My Income Compounder Portfolio (2024)

In my recent and most popular article to date on Seeking Alpha, I reviewed the top 10 holdings in my Fidelity IRA Income Compounder portfolio that delivers income on a mostly monthly basis that amounts to an average annual yield of about 15% at today's prices. That piece generated a lot of comments, many that were positive and appreciative and some that were challenging my recommendations. It occurred to me that I probably should have prefaced my article with a bit of explanation regarding my Income Compounder method, the rationale behind it, and my personal beliefs with regards to choosing income investments versus growth-oriented holdings.

As a recent retiree, my goal for my investments is to generate a steady stream of passive income that will help to replace my paycheck that I am no longer receiving. I am no longer in accumulation mode and am not trying to grow my overall portfolio value. My sole focus is on current and future income to support me for the next 30 years, or however much longer I have left to live. I am no longer trying to save to buy a house or put my kids through college - already been there, done that. I have now reached the "decumulation" phase of my investing path. I want to spend what I have stashed away for my retirement after a 42-year career working my butt off. But I also want those savings to last, and there is a fine line between spending and maintaining enough capital to support future spending.

This is the crux of my IC strategy, which is different than a DGI (dividend growth investing) or Total Return strategy. Yes, total return is important because I do not want to run out of capital before I die. But TR is not as important to me now as the amount of income generated from my investments. The prices of my holdings change daily, and thus my total portfolio NAV (net asset value) also changes daily. But it does not matter to me whether my portfolio NAV is $500,000 or only $450,000 if my income still generates enough to cover my monthly needs and wants. This is a difficult concept for many to grasp because we are constantly reminded of the value of major market indexes and how much total return those investments (should) generate based on recent history. I am not trying to "beat" an index or do better than the average investor, I just want to select appropriate investments for my investing goals.

One of my mentors who has taught me a lot about investing for income is fellow SA analyst, Steven Bavaria. His approach to investing for income has very much shaped my IC strategy, which focuses on the power of compound interest.

According to Einstein, "Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn't … pays it."

One last point of introduction is that my IC portfolio is really split into two separate IRA accounts. One is with Fidelity and the other is with Schwab. This article will discuss six of my Schwab income holdings.

The primary difference between the two portfolios is that the Fidelity account mostly includes CEFs that offer a discount to DRIP (and some additional holdings that I have added over the past six months). That Fidelity portfolio started last summer with about a dozen funds that I transferred from Schwab (which I originally bought in my old Scottrade IRA, which then got bought by TD Ameritrade and then Schwab took over). The reason why I transferred those funds is because Schwab did not support the discounted DRIP even though the funds clearly state that they offer that benefit to shareholders.

In my Schwab account, which now represents about one third of my total investment portfolio by market value, I still hold about 20 different securities, but none that include CEFs that offer the discounted DRIP. Instead, those securities that I currently hold in my Schwab account include several BDCs, REITs, ETFs, and CEFs that all offer high yield income. In this review, I will cover three BDCs and three REITs that I currently hold in my Schwab IRA and will briefly review the risk/reward profile of each so that investors can make informed decisions regarding their own investment goals.

The holdings that I will cover in this article include:

REITs: AGNC, IVR, EFC

BDCs: FSK, TRIN, CION

Real Estate Investment Trusts (REITs)

Without further ado, let's get into the REITs first and my reasons for adding the three that I mentioned above to my IC portfolio. For income investors, REITs typically offer a reliable high yield income stream that is mostly uncorrelated to the broader stock market. For the past several years, and especially since the start of 2022, REITs have underperformed most other market sectors due to rising inflation and interest rates moving from zero to 5% in a relatively quick period. However, the outlook for the real estate sector shifted back in November 2023 when the Fed first hinted that rate hikes may have ended.

Although the real estate sector is still the worst performing market sector YTD, 35 REITs increased the dividend in the first quarter of 2024 and at least 19 more REITs have announced (or are expected to announce) an increased dividend in Q2. While interest rates remain elevated, they are no longer increasing, and that stability of interest rates has enabled some REITs to begin the turnaround that many were expecting when the Fed pivoted late last year.

AGNC

At the closing market price of $9.66 on May 10, 2024, AGNC Investment Corp (AGNC) offers income investors an annual yield of about 15% based on the dividend of $0.12 paid monthly.

While the past performance of AGNC has been unimpressive to those who simply look at a price chart, the actual performance of the stock has been quite impressive from an income investor's perspective. In fact, according to the company's Q1 earnings report, the amount of dividends paid out to shareholders since inception has far exceeded the loss in price:

Since its May 2008 initial public offering through the first quarter of 2024, the Company has declared a total of $13.1 billion in common stock dividends, or $47.56 per common share.

Ever since the stock hit a 52-week low price of $6.81 back in October 2023, the price has risen by about 15% while continuing to pay out a monthly dividend. As real estate continues to recover in 2024, the price may remain volatile until interest rates do start to decline, but the dividend is well covered and is unlikely to be cut any time soon.

As noted in the Q1 press release, the outlook for Agency MBS continues to give AGNC management reason for optimism, as explained by President and CEO Peter Frederico:

Although the first quarter unfolded largely as expected and in a positive way, the start of the second quarter has illustrated that challenges remain. In April, interest rates and interest rate volatility increased meaningfully as the timing and magnitude of rate cuts in 2024 became increasingly more uncertain and as the conflict in the Middle East escalated. Despite this recent volatility, the underlying fundamentals for Agency MBS continue to give us reason for optimism. As a highly liquid, levered Agency MBS-focused investment vehicle, AGNC is well positioned to benefit from these favorable investment dynamics as they evolve over time.

The company's tangible net book value also increased in Q1 from $8.70 per share as of 12/31/23 to $8.84 per share as of March 31, 2024. Additionally, the company earned $0.48 in comprehensive income per common share, more than covering the $0.36 paid in dividends.

IVR

While Invesco Mortgage Capital (IVR) is another REIT that struggled to deliver strong returns in the past, it too has shown strong signs of recovery this year. On April 26, Seeking Alpha published my article on IVR where I suggested: Buy This 18% Yielding REIT While It's Still On Sale.

My rationale for making that recommendation is similar to what I just described for AGNC because IVR also holds mostly Agency MBS assets. From the Q4 2023 earnings call, CIO Brian Norris suggested that 2024 is shaping up to be a very attractive opportunity for investors in the Agency MBS space.

On May 9, IVR reported Q1 2024 earnings results, which "missed estimates" but still suggested that the stock is well positioned to deliver strong performance in 2024. Some of the highlights from that press release include:

• Net income per common share of $0.49 compared to $0.46 in Q4 2023
• Earnings available for distribution per common share of $0.86 compared to $0.95 in Q4 2023
• Common stock dividend of $0.40 per common share, unchanged from Q4 2023
• Book value per common share of $10.08 compared to $10.00 as of December 31, 2023
• Economic return of 4.8% compared to 4.7% in Q4 2023

With EAD (earnings available for distribution) of $0.86 the $0.40 per share quarterly dividend is well covered. And as CEO John Anzalone explained on the Q1 earnings call, despite more near-term uncertainty regarding interest rates, the company is well positioned to take advantage of the opportunity in Agency MBS for long-term attractive returns.

Over the longer term, however, the potential normalization of monetary policy and a steeper yield curve should be supportive of agency mortgages. We believe agency mortgage investors stand to benefit from attractive valuations, favorable funding, and robust liquidity as the macro environment evolves.

Although IVR's stock price has risen by more than 20% in the past six months, we can likely expect some continued price volatility in the short term. But the dividend is well covered so income investors might still consider adding shares before interest rates do get cut and the stock price shoots higher.

EFC

When I wrote about Ellington Financial (EFC) back in January, it was shortly after the Fed pivot that had most people believing that interest rates were due to be decreased in the first half of 2024. Although many consider EFC to be an mREIT it is actually more of a hybrid REIT. With its recent acquisition of Arlington Asset Investment Corp completed in December, I believed at the time that the prospects for growth and recovery in the real estate market would likely support the continued payout of the monthly dividend that was yielding 14% at the time the article was published.

Unfortunately, Q4 2023 earnings results were not as good as I had hoped with only $0.27 per share of adjusted distributable earnings, and the dividend was reduced from $0.15 per share monthly to $0.13. On May 7, the company reported Q1 2024 results and there was some improvement over Q4 earnings, but the company is still rebuilding and deploying uninvested capital that resulted from the AAIC acquisition.

"Steady performance from our non-QM and residential transition loan businesses, together with strong returns from our secondary CLO, CMBS, and non-Agency RMBS portfolios, drove Ellington Financial's first quarter results," said Laurence Penn, Chief Executive Officer and President.

We continue to focus on deploying the uninvested capital we held at year end following the closing of the Arlington merger. Our credit portfolio grew sequentially during the first quarter, driven by an expanding RTL portfolio and opportunistic CLO purchases. We also grew our commercial mortgage bridge loan portfolio, after five consecutive quarters of payoffs exceeding new originations in that portfolio. With borrowers finally more realistic about commercial real estate property valuations, we are seeing strong origination flow from our affiliate Sheridan, which has also sourced two NPLs for us so far in 2024.

While the company is continuing to pay out the reduced dividend of $0.13 per share monthly, the forward yield is now closer to 13.5% as the company works to build back up the adjusted distributable earnings, which were reported at $0.28 per share for Q1.

We continue to work hard to get more fully invested in our higher-yielding strategies, drive origination profits at Longbridge, and work through the few sub-performing loans in our commercial bridge loan portfolio, as we build back up Adjusted Distributable Earnings. We continue to be patient on deployment, balancing the dual goals of growing earnings in the near term while preserving dry powder to capitalize on opportunistic situations as they arise.

EFC remains one of my largest REIT holdings, but I remain cautious regarding the short-term price action and will be watching closely as events unfold over the next three months.

Business Development Companies Deliver Strong Returns

As REITs have struggled with rising interest rates affecting their returns, BDCs have benefited from those elevated rates. Some BDCs have performed better than others and I have been invested in multiple BDCs (as many as seven different BDCs last year) but only intend to review the three that I currently hold in my Schwab account. That is not to imply that these three are the best of all publicly traded BDCs, but they have performed well for me, and I believe that they will continue to deliver high yield income for the foreseeable future. I also believe that as interest rates do come down later this year or next year, that BDCs in general will start to struggle, so I do not want to have too much portfolio concentration in that asset class.

FSK

In my latest review of FS KKR Capital (FSK) that was published in January of this year, I wrote about Finding Opportunity In Every Difficulty. The title of that article comes from a Winston Churchill quote who suggested that an optimist looks for opportunity in every difficulty. At the time, many were concerned that the US stock market was topping out and that we were destined for a crash. This is what I wrote in that article:

Now at the end of January 2024, FSK still trades at a big discount to book value, offers a high yield distribution, and continues to outperform its peers (although OBDC is catching up and did provide a better total return in 2023). I still rate FSK a Strong Buy today and will review some of the reasons why I feel this way in the paragraphs below. I currently own shares of FSK in my Income Compounder portfolio and it is one of my largest BDC holdings.

About a month after my January article was published, Q4 2023 earnings results were reported by FSK on February 26. The report was not encouraging with NII (net investment income) declining to $0.71 per share from $0.84 for the quarter ending 9/30/23. NAV also declined slightly from $24.89 at the end of September to $24.46 per share as of 12/31/23. EPS also declined from $0.95 in the September quarter to just $0.32 in Q4. Nonaccruals were reported higher than peer BDCs and the market responded by slashing the market price of the stock over the course of the next several weeks. The market price eventually bottomed out at a price of about $18.50 as can be seen in this YTD price chart.

Nonetheless, the dividend remained at the same level including the supplemental dividend declared for the quarter, in addition to the previously declared special dividend as explained in the press release:

FSK's board of directors has declared a cash distribution for the first quarter of $0.70 per share, consisting of a base distribution of $0.64 per share and a supplemental distribution of $0.06 per share, which will be paid on or about April 2, 2024 to stockholders of record as of the close of business on March 13, 2024. FSK's board of directors previously declared special distributions totaling $0.10 per share to be paid in two equal installments during 2024. The first $0.05 per share special distribution will be paid on or about February 28, 2024 to stockholders of record as of February 14, 2024. The second $0.05 per share special distribution will be paid on or about May 29, 2024 to stockholders of record as of May 15, 2024.

In my opinion, one bad quarter does not necessarily indicate a bad investment, especially when the income being delivered in the form of base, supplemental, and special dividends amount to $0.75 per quarter. I held onto my shares of FSK and even added more in the mid $18 price range to lower my cost basis and increase my future income stream.

On May 9, FSK reported Q1 2024 earnings results and turned in slightly better than expected earnings, indicated improvement in nonaccruals, increased investment activity, and announced the same dividend payout amounts for Q2 of $0.75 including base, supplemental, and special. The market responded positively, sending shares to a closing price of $19.87 as of May 10, 2024.

As an income investor this volatile price action in the stock allowed me to purchase more shares at a lower price after the Q1 report to lower my cost basis and increase my future dividend payments. On a total return basis there are "better" BDCs available including MAIN, ARCC, and OBDC, but none of those pay out as much in dividends as FSK.

TRIN

A relatively new entrant to the publicly traded BDC market is Trinity Capital (TRIN). While TRIN is relatively young and still growing, it is doing so with vim and vigor. Over the past three years, TRIN has delivered a total return of nearly 50% (double that of the S&P 500 for those keeping track) and has increased the dividend multiple times. TRIN has also delivered a total return that is comparable to those peer BDCs: MAIN, ARCC, and OBDC.

But the most impressive aspect of TRIN to me as an income investor is that the company has increased the base quarterly dividend every single quarter since it went public in 2021 as shown on the Dividend History page.

In addition to the increasing base dividend, TRIN also paid out two special dividends in 2022 and two more special dividends in 2023.

As explained in the Q1 2024 earnings call by CEO Kyle Brown, the company has experienced 38% YOY growth in AUM and a 30% increase in NII.

Platform AUM growth of 38% year-over-year, pushing our assets under management to $1.6 billion. Record net investment income of $25.2 million, a 30% increase versus Q1 of last year and return of equity of 16.1%. Our performance allowed us to increase our quarterly dividend to $0.51 per share in the first quarter, making this the 13th consecutive quarter we've increased our dividend.

I would recommend reading more on the earnings call if you would like to know more about the future of TRIN and I highly recommend an investment for the continued high yield income that it pays out each quarter.

CION

Last but not least for this discussion, anyway, is CION Investment Corp (CION). Like TRIN, CION is a relatively new public BDC although it was privately owned for nearly a decade before going public. I have written about CION multiple times but most recently about a year ago: CION Investment: This Strong BDC Outperforms In 2023. In that article I discussed how CION had outperformed peer BDCs like ARCC, FSK, OBDC, and OCSL over the six months prior to that article's publication in April 2023. Comparing total return performance over the past year, CION still outperformed all the others except for OBDC, which had a very strong year.

The reason for CION's outperformance is based on the company's focus on private equity and lending to middle market companies in the US as I summarized in that article.

Private equity funds tend to leverage their investments in smaller and middle market companies with a combination of equity capital combined with senior secured and mezzanine loans from other sources. CION can offer the role of leverage provider in some of those instances.

On May 9, 2024, CION reported Q1 2024 earnings results and declared an increase in the base quarterly dividend to $0.36 per share, an increase of $0.02 compared to the Q1 dividend of $0.34. For the quarter the company reported NII of $0.60 per share and EPS of $0.12. NAV declined slightly due to mark to market price declines of the company's portfolio from $16.23 at the end of December to $16.05 as of March 31. Investments on non-accrual status declined in the quarter.

As of March 31, 2024, investments on non-accrual status amounted to 0.86% and 2.88% of the total investment portfolio at fair value and amortized cost, respectively, compared to 0.89% and 3.47%, respectively, as of December 31, 2023.

Co-CEO Michael Reisner summed up the quarterly results with an optimistic outlook for the remainder of 2024:

We reported another solid quarter this morning, continuing our momentum from 2023. Given our strong distribution coverage and outlook for the long-term earnings power of our portfolio, I am excited to announce an increase to our quarterly base dividend to $0.36 per share, up from $0.34 per share last quarter. The underlying credit performance in our portfolio remained strong, with non-accruals improving to 0.86% of fair value. While these trends reflect the rigor of our underwriting discipline and we are optimistic for continued performance in 2024, we remain conservatively levered on a net basis. As we look at our origination pipeline, we continue to see ample opportunities to deploy capital at attractive spreads to qualified middle market borrowers.

Summary: 3 BDCs and 3 REITs to Consider for the Income

Keeping in mind that I am interested primarily in the income generated by my investments, I have provided summary thoughts on six investments that all offer high yield dividends delivering 10% or more on an annual basis going forward. In some cases, those high yields may suggest higher than tolerable risk for investors who are concerned about "losing capital". For the most part, these investments should provide steady to increasing income based on current economic and market conditions, but if those conditions should suddenly change the risk/reward profile may change.

I enjoy actively managing my IC portfolio but not everyone does. These ideas may not be suitable for "buy and hold" investors who do not wish to spend the time to monitor their holdings. BDCs tend to perform well with rising interest rates but if those rates suddenly come down that could negatively impact the returns on BDC investments. Conversely, if rates were to increase again to the astonishment of many market prognosticators, that would be bad for REITs. So, plan accordingly and watch the price action of these and other investments in the BDC and REIT asset space and invest appropriately based on your own investment goals and risk tolerance.

Damon Judd