CCD - Live Off Dividends With 2 Great Picks

2023-03-08 11:00:00 ET

Summary

• Do you have a plan for your retirement, or are you relying on the one the government has for you?
• You are never too young to be a passive income-focused dividend investor.
• Use this bear market to your advantage; two picks with up to ~10% yields for a happy and healthy retirement.

Co-produced with "Hidden Opportunities"

Despite the increased and cost-effective availability of financial advice over the internet, about 37% of Americans retire without savings . Many Americans believe their limited savings and social security benefits are sufficient for their needs.

Time is on your side if you are in your 20s or 30s. You can use it to plant passive income seeds by buying high-quality businesses with shareholder-friendly operating models. Warren Buffett invested in quality dividend payers like American Express ( AXP ) and Coca-Cola ( KO ) during troubled economic conditions in the 1970s and 1980s. Today, these securities are paying the lion's share of Berkshire Hathaway's ( BRK.A ) ( BRK.B ) dividend income.

Someone is sitting in the shade today because someone planted a tree a long time ago. - Warren Buffett

If you are in your 40s or 50s, it might be time to evaluate your retirement needs and get more serious about establishing a reliable revenue stream. The better you execute this, the sooner you can retire.

If you are in your late 50s and 60s, you need to ask yourself a few important questions - when do you want to hang up your boots? What will be your sources of income in retirement? Are you planning to work until 70 to be entitled to increased Social Security benefits? Are your savings enough to sustain the next chapters of your life?...

While dividend income is not risk-free, diversification will be your ally; the more dividend payers you have, the more stress-free your retirement. At HDO, we recommend a portfolio of 42+ dividend producers, so your retirement does not involve staring at the news and your portfolio all day. Without further ado, we will introduce two picks with up to 10% yields to boost your retirement income.

Pick #1: CCD - Yield 10.2%

• Calamos Dynamic Convertible and Income Fund (CCD)

Investors love history, and the media knows this well. But they also know that bad news sells well. When the markets are rocky, I see a lot of charts and analyses showing a lot more downside ahead.

We like history too, but we look to utilize it to further our long-term interests and not guide near-term trading decisions. The hot inflation we face today is comparable to the '80s. But it is notable that when inflation peaked at that time, convertible debentures outperformed both stocks and bonds over the next two years. Source

Convertible bonds are hybrid securities that pay a fixed interest rate and allow investors to exchange the debt for the issuing company's shares if the stock price appreciates. The nice feature of these convertibles relative to the stocks is that investors stand to do well if the companies merely survive, barring debt restructurings. That's a significantly lower bar than for the investors of the common stock.

Calamos Dynamic Convertible and Income Fund is a CEF (Closed-End Fund) that actively manages a massive portfolio of convertible securities. With 589 holdings, Calamos fund managers move in and out of positions to realize timely gains, and the proceeds are used to pay big distributions. Source

No, CCD isn't heavily allocated to securities issued by unprofitable tech. The CEF maintains significant allocations in IT, Healthcare, and Consumer Discretionary sectors and has modest positions in defensive sectors such as industrials, utilities, financials, and energy.

CCDs' top 10 holdings only constitute 16.3% of total assets, and several are highly established and profitable names in their respective fields.

CCD distributes $0.195/share every month, calculating to a 10.3% annualized yield. Now let's look at CCD's distribution source in FY 2022 and the four months of FY 2023.

CCD sourced its recent distributions primarily from capital gains (mostly long-term). Most importantly, there was no Return of Capital (which some investors find distasteful, albeit it comes with tremendous tax benefits). This approach is sustainable since companies are always going to be raising capital and will issue convertibles. 1H 2022 was a terrible time for convertibles, with only $11 billion worth issued globally during the year. But things improved in the second half, with funds raised almost double the amount by the end of the year. December was notably the busiest month of the year for convertibles.

"Converts are always a market that tends to be interesting to a broader array of companies when other markets are experiencing difficulties because of their greater certainty of execution." - Craig McCracken, co-head of equity capital markets at Wells Fargo

Fundraising in the U.S. equities market is at its lowest level in over three decades. More U.S. companies are turning to convertible bonds to raise funds. This method is beneficial as it keeps borrowing costs low and is non-dilutive at distressed bear market valuations. And CCD is well-positioned to benefit since ~70% of the portfolio matures in <5 years. This allows the CEF to realize the proceeds and move into newly issued debentures. With CCD in your portfolio, you can collect a sizable and sustainable income from this much-needed fundraising tool during uncertain market conditions.

Pick #2: CIM Preferred Stock - Yields of +9%

• 8.00% Series A Cumulative Redeemable Preferred ( CIM.PA )

• 8.00% Series B Fixed-to-Floating Rate Cumulative Redeemable Preferred ( CIM.PB )

• 7.75% Series C Fixed-to-Floating Rate Cumulative Redeemable Preferred ( CIM.PC )

• 8.00% Series D Fixed-to-Floating Rate Cumulative Redeemable Preferred ( CIM.PD )

Chimera Investment Corp. ( CIM ) is a mortgage REIT investing primarily in loans and MBS (mortgage-backed securities) that are non-agency. Source

Due to this, CIM carries higher credit risk than mREITs that invest in agency MBS, as reflected by higher preferred coupons with attractive floating rate components. That means higher volatility and interest rate sensitivity, but since the Great Financial Crisis, we have a much better system in place.

1. Increased regulation and transparency in lending

2. Improved underwriting standards

3. Improved credit situation of homeowners

Additionally, delinquencies have continued to migrate below pre-COVID levels, and home equity has reached record levels , given the recent surge in housing prices. The National Loan-To-Value ratio , indicative of homeowner equity levels, is below 30% (meaning - the average homeowner only held a mortgage balance worth about 30% of their current property value). Even if home prices drop by 10-20%, homeowners would still have sufficient equity cushion to weather the impact.

To sum up, the case for a significant housing market crash like the one we saw during the GFC is feeble. With that, we look to CIM's preferred securities, where we see attractive discounts and well-protected high yields.

CIM spent ~$55 million on preferred dividends during the nine months of FY 2022, compared to $212 million on common dividends. These payments are covered by the mREIT's $300 million in net cash from operating activities during the period. While sufficient common dividend coverage is notable, it is essential to point out that the quarterly preferred dividends enjoy 6x coverage.

Readers will be quick to point out that CIM's common dividend has been on the decline since 2020. CIM has reduced common dividend payments twice since the pandemic's beginning, and the company's operations currently cover the common dividend.

But as a shareholder of CIM's cumulative preferreds, you stand to be paid all missed dividends (if any) before $0.01 is paid to common shareholders. It is important to note that CIM preferred dividends have never been missed since their inception. There are four classes of preferreds, each with unique benefits based on your requirements.

• CIM-C is the most discounted, offering an attractive 9.6% yield and up to ~24% upside to par value, and presents the best option for high current income.

• CIM-D also comes with a high +9% yield but will change to a floating rate in 13 months (if not called) and has prospects of offering an even higher base coupon in this rising rate environment.

• CIM-B can be considered an alternative to CIM-D because it has a higher floating rate.

• If you don't prefer to have the floating component in the preferred, then CIM-A offers a 9.3% yield and up to ~15% upside to par value.

CIM survived a loosely governed pre-crisis non-qualified mortgage fiasco and is operating in a much tighter regulated environment today. The mREIT's preferreds offer attractive bargains and well-protected income to ride this rocky interest rate cycle.

Conclusion

The chart below shows the average amount saved by parents in their children's 529 plans. American parents expect their children to pursue a college education and are beginning to save for it at very early stages. Source

But when it comes to their own retirement, people often wait until the last few working years to plan. Somehow all the eggs are placed in the basket designed by government agencies and politicians. Yes, Social Security is available, but do you really want to retire when your elected leaders tell you to?

To better control what you want to do in your golden years, you need to be in the driver's seat of your retirement planning.

You are never too young to focus on dividend income. Unlike the famous 4% rule, dividends have proven capability of fueling a healthy retirement without depletion of the principal. Like clockwork and requiring no effort on your part, the dividend stocks and funds you hold deposit recurring dividend payments into your brokerage account throughout the year. At HDO, we target a 9% yield on our assets, so our capital works hard to sustain our lifestyle. Use this bear market fear to boost your portfolio income; two +9% yielding picks to consider adding to your portfolio for a long and healthy retirement.

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