Filling out the Special Situations Portfolio

Earlier this year I put out a special report to add several positions to the Hack Wall St. portfolio and dismiss a few.  The report left about 25% of the portfolio in cash, which is where we stand today.  To access this report, which discusses the addition of several country ETFs as well as Ferrari, subscribe to my newsletter.

Even earlier this year, my now fiancée and I managed to save a down payment for a new house in just six months partly by using closed-end municipal bond funds.  Our strategy was to pay $1,500/month to ourselves in rent and send it all into a brokerage account where it would be invested.

The savings part was easy enough – we just had to commit to it.  The hard part was deciding how to invest the money.

We could pick blue-chip stocks paying dividends, but even the least volatile blue chips could lose 20% suddenly with little or no warning.

We could just keep the money in a savings account or use short-term CDs, but the people who do that don’t run personal finance websites.

We could sell puts on blue chip stocks using the cash as collateral, but again there is an, albeit slim, potential for a huge loss.

Our selection was Closed-end funds (CEFs) holding municipal bonds that trade at a discount.  We get conservatism with the municipal bonds – if they defaulted we probably wouldn’t be looking to buy a new house either way.  We also got an alright return with a 4-5% non-taxable yield; this converts to about 6% for a taxable asset.  Finally, we picked closed-end funds that traded for a discount to their net asset value (NAV).

Here’s how that works.  The net asset value is the actual value of the holdings in the fund – in our case it would be the value of the municipal bonds and any cash in the fund.  The fund trades on the open market, so depending on the feelings of the market it can trade below (discount) or above (premium) to its net asset value.

Many closed-end funds will trade at discounts their entire life – or at least until an activist gets a controlling share and riles up management.  With municipal bond funds, the asset value has so little certainty that it is very likely that at some point the fund will trade at a premium or at the NAV.

This worked out for us.  Including the yield and the reversion to the mean, we earned about 8% in just six months holding the CEFs.  All in all, the return subtracted about a month from the amount of time it took to save.

I’ve written about the mechanics of this strategy before and how to find and evaluate funds and what types of portfolios this strategy works in. You can find that article here. 

In the past couple of months, these CEF opportunities dried up.  The strategy obviously works, so investors were piling into it.  However, following election day, the market became convinced that interest rates would rise – which pushes bond prices down – and many muni bond CEFs fell in price and now trade at a discount.

Using the method described in the article linked above I found three good opportunities: NXP, AKP and VPV.  We will put 5% in each and sell if they hit a 5% premium or we find a better opportunity for the portfolio.

For the current portfolio, visit this page. 

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