Building an Unconventional Portfolio

 | Apr 04, 2012 | 3:30 PM EDT  | Comments
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Stock quotes in this article:

fly

,

cwh

At long last, baseball season has arrived and the universe is back in balance. I have a long weekend of games to look forward to, starting with the kickoff game tonight between Miami and Saint Louis. Friday will find me in the comfortable confines of Camden Yards as the Orioles kick off what will likely be another futile season.

Although Opening Day is the focus of much of my attention, I am always focused on the markets as well. One idea being tossed around this week is that of building a portfolio of unconventional yield stocks for total return and current income needs. I think it can be done but it takes work and a tolerance for higher volatility than income investors might normally find comfortable. As with everything I do this approach will take discipline and patience.

I spent some time looking for stocks that have traded well below book value and have high-dividend yields. These situations have provided me with some huge winners over the year but have also been the source of a couple of notable bombs. The trick to using the unconventional yield approach is to own a several different names and try to diversify across industries whenever possible. Stocks with super high yields are experiencing some measure of difficulty, so doing the homework is critical to putting together a portfolio of unconventional yield stocks.

One of the first names on the list is an old favorite of mine. Shares of CommonWealth REIT (CWH) have not done a lot in the almost four years I have owned them. The shares have sold off into the mid-teens a few times, and I have added a little bit more to my position. Last year, they shot up to $27 for a period of time and a smarter trader than I would have sold a little. I did not, and still hold all of  my shares. Commonwealth just did an initial public offering (IPO) for its Hawaiian Properties and received an inflow of $400 million and still owns 73% of the new shares of Select Income (SIR). Management continues to focus it efforts to dispose of suburban commercial and industrial properties to concentrate on central business district commercial properties. I have collected over $7 a share in dividends since my original purchase and am quite content to own this stock until the commercial real estate market has fully recovered. With the shares trading at 50% of tangible book value, there remains enormous upside price potential in a fully recovered economy.

One stock on the list I find intriguing is NGP Capital Resource Company (NGPC). The business development company invests in middle market companies with a concentration on energy companies. The company has a large exposure to the natural gas exploration and production industry with loans to companies like ATP Oil and Gas (ATPG) and GMX Resources (GMXR) among others. At year-end, the portfolio had 19 companies with a weighted average yield of 11.7%. Management decided to cut the dividend in this quarter from $0.18 to $0.12 to conserve cash and keep the payout in line with earning expectations. The stock sold off on the announcement and the shares now trade at 70% of the tangible book value. After the dividend reduction, the shares still yield more than 7%. I am very bullish on the energy sector (including natural gas) over the long term, and NGP Capital is a way to benefit from the industry and get paid well while you wait for conditions to improve.

Fly Leasing (FLY) is another old favorite that remains on my unconventional income list. The airline leasing company currently has 111 airplanes leased to 53 different airlines with an average remaining lease term of 3.6 years. Not only do they do a good job of managing the business management at Fly has done an incredible job of managing the balance sheet. Since their IPO in 2007 the company has repurchased 24% of the original shares. It has grown from 49 airplanes to 111 with no new equity offerings. The company repurchased its secured debt during the credit crisis at $0.49 on the dollar and just resold the notes for 0.82% on the dollar, which generated $78 million. At their current price, Fly Leasing shares trade at 70% of tangible book value and yield over 6%.

Building a portfolio of unconventional yield stocks takes time and effort. These stocks can be highly volatile -- especially in down markets. Experience has taught me that focusing on a diversified portfolio of high yield stocks can offer high total returns in addition to current income, but it is not a smooth ride. This approach takes patience and discipline but it does work.

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