mREITs can provide safe haven

Federal Reserve chairman Ben Bernanke’s announcement that the government would launch another economic recovery program, this one now popularly known as “Operation Twist”, sent the stock market into a tailspin on Thursday, September 22.
The Dow fell 3.5 percent to 10,733.83, completing its biggest two-day loss since December 2008.
Anticipating rough waters, we reduced our equity exposure to approximately just 10%-20% some time ago. One area that has been providing a safe haven during this prolonged period of economic stress is in mortgage Real Estate Investment Trusts (mREITS).
In general, REITs enjoy some of the highest yields on Wall Street. To be classified as a REIT, a company has to distribute at least 90 percent of its taxable income to shareholders annually in the form of dividends.
These mREITs borrow at low rates and lend in the mortgage markets at higher rates, usually by buying mortgage-backed securities. Because of this, lower interest rates have meant higher yields for this type of investment.
The Federal Government has committed to extraordinarily low short-term interest rates (between 0% and .25%) through 2013. These low interest rates allow mREITs to borrow money and use that money to purchase mortgage-backed securities. By using those securities as collateral to secure even more financing, mREITs assume significant amounts of leverage. They profit from the spread between the returns they get from their mortgage investments and the financing costs they pay on the funds they borrow.
The leverage gained from financing their operation in this way allows them to pay significantly higher dividends than other income-producing stocks.
An example of one mREIT we like is Annaly Capital Management (NLY), which is currently paying dividends of 14.5%. Formed in 1997, Annaly’s management team has a proven track record of successfully managing their portfolio through various interest rate cycles. NLY is by far the largest mortgage REIT (by market cap) and it has a very tenured management team with a proven ability to manage its mortgage portfolio through various interest rate environments, according to Parsimony Investment Research.
While we continue to be concerned about the overall state of the economy and anticipate turbulence for some time. We currently are using mREITS in both our portfolios and in our mutual fund.
Of course, these mREITs will not be paying out-sized dividends forever. When the economy recovers, the interest rate spreads that these companies use to leverage their profits will narrow and dividends will fall. At that time, we will look at growth equities, which will be attractively priced and ready to rebound.
This is just one example of the effectiveness of Winch Financial’s active management system.