Date: Fri, 20 Feb 2004 03:58:53 CST
From: "Caroline" 
Newsgroups: misc.invest.financial-plan
Subject: Re: Retirement time drawing near.
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"Tad Borek"  wrote
> Caroline wrote:
> > Several weeks ago another poster here suggested using www.quantumonline.com
for
> > preliminary searches for "exchange traded income securities" that pay high
> > yields, like certain preferred stocks. I registered there (it's free), then
> > clicked on "Income Tables," then "Exchange Traded Income Securities." Many
high
> > yield stocks come up, and many have investment grade Moody ratings. (These
> > stocks pay interest, not dividends, and are so some sort of hybrid between
> > non-preferred stocks and bonds, as I trust you  are aware.) They tend to
yield
> > way more than what an investment grade, long-term corporate bond yields
right
> > now. For example, GEA, IJD, and KTB are yielding around 6% and have Aaa/AAA
> > ratings.
> >
> > Right now, what I'm trying to "forecast" with these highly rated securities
is
> >
> > 1. how would I feel if their price dove
> > 2. the likelihood of a price dive while I am waiting for them to mature
> > 3. the effects of conversion (to non-preferred company stock) on my
portfolio
> > (e.g. convertible preferred stock)
> > 4. how closely I need to watch them; Do they tend to stay pretty steady in
> > price?
> >
> > If they are pretty steady in price, then it seems to violate the rule
"there's
> > no such thing as a free lunch."
> >
> > I guess the yields of these highly rated preferred stocks are higher
precisely
> > because there is the risk the price will go down. An Aaa/AAA rated preferred
> > stock is not quite comparable to a similarly rated corporate bond that one
plans
> > to keep to maturity. The preferred stock is riskier.
> >
> > Comments from you or others are welcome, especially those who have traded
for
> > more than five years in high yield, highly rated preferred stocks.
>
> Caroline,
> A few comments about these securities:
>
> 1. In general, their priority is lower than bonds, so they should
> provide higher returns. ('priority' in the bankruptcy sense) In Ch11 BK
> the preferreds will in most cases be cancelled, and it's almost as
> likely for the income trusts (MIPS, QUIPS, etc). Bondholders should get
> something though, even if not made whole. This is a consideration not
> just in BK but in connection with any debt-rating downgrades. As an
> example, the airline issues have all sorts of risks. Someone concerned
> about growing consumer debt might steer clear of the securities that
> rely on those debts for income.

BK = ?

Otherwise, okay, 1. partly explains why the yield is higher.

> 2. A diligent analysis will often require digging up the original
> filings via EDGAR, so you can see all of the provisions associated with
> the security, and understand exactly what cash flows are providing your
> dividends. A common provision is some type of call and you need to
> factor that into your analysis.

Yes, I notice the quantumonline list is chock full of callable issues.

Is there an easy online equivalent to EDGAR where there is no fee?

I can dig and get a lot of info online, but from what I see about EDGAR, it is
more efficient. I just don't want to have to pay for a service IF I do not have
to. :-)

> A 9% yield does no good if you won't
> receive it. Quantumonline is great & I recommend using it (and have used
> it myself for years), but I don't think it's a good idea to rely on it
> for that level of detail.

I agree. I bounced a few of the stocks at the Quantum list off the Yahoo
financial listings and found some differences immediately. Quantum does have
some sort of fairly prominent disclaimer on this. It does note the date of the
Moody ratings, and some are a year or more old, IIRC.

> 3. Put your tax hat on & think in terms of supply/demand for
> these...true preferreds are attractive to corporations because the
> dividends

Just to really confound point 3, might you mean "interest" instead of
"dividends" above? And yes, it makes sense that corporations are taxed
differently on these, thus the yield is different, etc.

Many (all?) convertible preferred's pay interest, not dividends, to the
individual, who likewise pays taxes on the interest.

This is a drawback for the individual right now.

Though maybe it helps explain the higher yields, too.

> aren't taxed the same way as other income. And they're
> attractive to you because of the 15% cap in dividend tax. So it's
> similar to munis where, when comparing issues, it helps to think ITO
> after-tax returns. Some return variations are explained by taxes.

Okay, especially the last sentence above.

> 4. Also re: supply/demand - I don't know why anyone would bother with
> new issues.

Do you mean brand spanking new *stock* issues?

I tarry over new issue bonds because the purchase fee/commission is "zero." Not
so for secondary market bonds. ("Zero" is in quotation marks because I assume
companies like Fidelity receive some sort of payment from the company issuing
the bond.)

> Let the market price the security and then assess it
> yourself. Buy new and expect to pay like...well like the person who buys
> next year's car right when it's released.

Hm. I'll have to think about this as an analogy, though this may be
over-analysis.

I haven't gone looking for new issue convertible preferreds that are about to be
issued.

Until recently, I owned some for a couple of years. Electric utility. (Many on
the Quantum list are electric utilities, which is something else I want to
research.) I actually learned about this from a relative, who got a suggestion
from his Edward Jones broker to buy some. (Aside for newbies: The relative is
now annoyed with EJ and the broker. He got "duped" into precisely the baloney
the media has covered; EJ pushing mutual funds etc. in which EJ has its own
interests. Fortunately, no significant damage done.)

I was very happy with the return. The price stayed around where I bought it or
rose. Only sold (and at a nice gain, too) to buy some real estate.

> 5. If you're considering taking on risk through a preferred, ie buying
> something that isn't AAA (not that you are but for the good of
> usenet...) be sure to weigh the alternative, which is buying the common.

My little experience shows that the common stock yields (dividends) tend to be
significantly lower.

> There are times where the potential upside of the common stock points
> towards buying it rather than the preferred.

Anyway, I'll do as you suggest.

> 6. Learn whether the dividends are cumulative or not, what can trigger
> suspension of a dividend, and what other issues have priority if
> dividends are suspended.

Okay.

> 7. With some issues (the income trust structures) there is the potential
> for a taxable event absent a dividend. The quick way to put it is that
> creation of the receivable is considered income. This isn't a problem in
> an IRA but it's a bummer to owe tax on a dividend you didn't get
> (especially because when it's not paid, it means things aren't going
> well and the price is low).

Okay.

> 8. A lot of what you'll find is REITs which should really be treated as
> a completely different asset class in your portfolio, and analyzed
> accordingly.

Maybe I'm misreading you, but I myself don't consider REITs in the same category
as convertible preferreds. Similarly, I don't see them on the Quantum list.
(Maybe we're just agreeing on this point.)

I am aware REIT yields are often good. Also a sizable portion of REIT yields is
often not taxable. But one somewhat off-putting reality I am now facing with one
REIT I currently own is the return of capital (ROC) is getting large. As you
surely are aware, but just to get it out there, the ROC reduces the cost basis.
If I hold this particular REIT a very long time, no big deal. This wasn't quite
my plan when I originally bought the REIT, so lesson learned.

> 9. I have no explanation for it but I do observe what I would call
> "mispricings" among these securities. Look at KTX (to point to a
> hindsight "win") in 2002 - I assume someone out there feels silly for
> dumping 20k shares that were about to return 150% (plus dividend, when
> the yield was 20%). Maybe it's because they aren't traded much but it
> does create opportunities. Unfortunately this requires following
> companies as well as their stocks and you might not want to bother.

I looked at KTX. Okay.

> 10. The yields may look tempting now but realize when you trolled this
> stuff a couple years ago you came up with tons of stuff in the 10%+
> range. Bonds are fully priced, junk bond yield premiums are very narrow,
> and it's a market at work, so there's no reason these would be immune.
> Show me an 8% yielder and I'll show you something that paid 11% not long
> ago, and that might very well pay 11% again in the future.

I'd appreciate your or anyone checking the following reasoning:

When interest rates do rise, this will drive the price of currently high rated,
high yielding convertible preferreds down. E.g. suppose 8% is the current yield
of a stock X but equivalently-rated stocks three years later are yielding 11%.
This drives Stock X's price down by about 28%.

How to plan?

Before buying Stock X, I think one should study what the conversion terms are.
If the conversion terms are favorable, then the risk is less. One then just has
to hold Stock X until it converts.

> 11. You do need to keep an eye on these. A portfolio of conservative
> preferreds ten years ago might have included some companies (eg
> utilities) that no longer exist.

Correct me if I'm wrong, but electric utilities do not seem to go bankrupt. What
utilities do you have in mind? Telecommunications?

> Kudos to you for doing the work, though - I think these can fit in well
> as an alternative to corporate bonds. Why more individual investors
> don't dig into these issues for income is beyond me.

Thanks for your comments.

All credit to the poster of a few weeks ago who first brought Quantumonline to
my attention.