Q3 2023: TAP Becomes Growth and Income

Turning TAP into a Growth and Income Fund

TAP: Tactical Allocation Portfolio

 For the last 17 years, conservative investors have had one hand tied behind their backs. With interest rates at or near zero on the Fed funds rate, there was truly no income to be had in any bonds or other instruments that had guaranteed – or at least protected – principal. This meant investors were continually faced either with the decision to take more risk or accept dramatically lower returns from their investments.

Most chose the path of taking more risk, following the herd and investing in grossly overvalued asset classes. In other words, participating in the current speculative fever. This works until it doesn’t, at which point much of the investment is typically lost. As you know, we have taken a different path – refusing to relax our risk level to profit from the seemingly unstoppable asset bubbles.
Instead, we have studied how to profit from the inevitable “reversion to the mean” – in profit margins and especially in valuations. This is the growth side of our “growth & income” strategy. It doesn’t change until the bubbles pop and what we own performs as expected. We then flip from our shorter-term, opportunistic approach based solely on profiting from historic bubbles to a long-term, mostly buy-and-hold approach.

When that day comes, i.e. the markets hit their ultimate bottom, we will need to look over each client’s portfolio with them to determine the ideal future allocations (how much growth, how much income, etc.). At the bottom, there will be a smorgasbord of great buys. We plan to offer four ways to select stocks for the long-term, high-income funds paying more than we’ve seen in decades (with price appreciation potential added in), a variety of real estate and related funds, plus two or three of the best, most proven quantitative funds.

Please note that half of what I’m discussing in this report – the growth side – doesn’t apply very much to our more conservative clients. When I changed TAP to provide steady, safe, 6% income, many of these clients asked me to leave it that way as much as possible going forward. We can do that – while still keeping enough in managed futures to protect against inflation.

What has changed is that – whether a person wishes to pursue growth or not – our portfolios will now have a 6% income target going forward. In fact, as described in this short article, the portfolio we envision owning during the next recession should give us our 6% income on the total portfolio with only 35% of the money allocated to income. (This assumes we’re able to buy when the yield is approximately 15 % plus.)

Plus, this 35% allocation of the portfolio will be going into a growth area, so we end up receiving 6% income on the total account plus growth potential on 100% of the portfolio. It should all work as designed – with a modest amount of patience needed to pinpoint when the opportunity is finally fully here and not going away again. It looks like this may have started in September when stocks (the S&P 500) fell 4.5%. If so, I would expect to have the growth side of our portfolio fully in place by December. This could be shortened substantially if the economy falters more quickly than presently anticipated, or lengthened.
If lengthened, we’ll simply sit safely making our 6% yield.

The next and most obvious question is, “How much should I go for growth?” You may be the best person to answer this question. I’ll try to help by describing this growth & income fund in some detail, and then we’ll also include information on our pure income-oriented portfolios.

Tactical Allocation Portfolio – Created for Conservative Growth/Growth & Income

First, please keep in mind that I’m constitutionally unable to manage retirement money without using probability theory to calculate the amount of risk I’m taking. Even though clients don’t sign on to a mathematical risk level – I do this for them. Right now, and until further notice, the maximum amount of risk I will take is indicated by a standard deviation of 9.5%. To put this into perspective, the Vanguard Balanced Index Fund (VNINX) has a standard deviation of 12.5%. This means the most risk I will ever take on the growth side in the Tactical Allocation Portfolio is 50% less than most retired investors are taking.

Today the Tactical Allocation Portfolio has a standard deviation of 2.5% – one-fifth as much as the Vanguard Balanced Fund (which has 60% in stocks & 40% in bonds).

In other words, the Tactical Allocation Portfolio has been, and will continue to be, unusually safe for any diversified retirement fund. The big difference is that now we’ve got the 6% income half of our value back, and the growth side appears poised to deliver as we’ve been anticipating.

The growth side of our portfolio is now slated to end up in four distinct asset classes – with very little to no correlations between each of the classes. These asset classes are projected to be:

#1.
35% in managed futures. We recently cut our allocations to these funds down in order to lower the current risk level, but will increase it back to 35% as soon as this most recent market reversal is established. We then plan to keep this allocation to managed futures until the dust has settled in the markets.

The money to add to our managed futures allocations will come from selling the one-year Treasury bond we purchased in the summer, as well as the PIMCO Enhanced Short Maturity fund (in some accounts only).

#2.
30% in Long Treasury Bonds.The moment the unemployment market “breaks,” we expect longer Treasury bond prices to come roaring back. Whenever that moment comes, we plan to sell some or all of the PIMCO Mortgage Opportunities fund and move it to the PIMCO Long-Term US Government (PGOVX) fund. Our time horizon for this purchase will be 18 months – 2 years. Rationale:

This fund simply owns 16-year Treasury bonds. Last year its bonds went down 29%, and through October 6, 2023 have dropped another 10.25 This is exactly what inflation does to longer-term bonds – fortunately we avoided these losses in TAP by selling all our longer-term bonds in January of last year.

Longer-term bonds perform terribly when inflation hits. While PIIMCO’s long Treasury fund is down 40% since last January,  even longer Treasury funds have lost a whopping 61%. As an entire market, the longest Treasury bonds –30-year bonds – are now selling for under forty cents on the dollar!

I see this as an opportunity to, potentially, make 40 to 50% fairly quickly. For us it will begin the moment the economy first clearly goes into recession, and it will continue until the Fed has plugged interest rates back down to historic lows. This sounds like perhaps 18 months to 2 years to me.

#3.
25% in distressed debt/special opportunity debt funds. This will be our new “secret sauce.” I call it this because this asset class (combined with the real estate fund described below) should allow us to generate 6% in income on the entire portfolio.

In order to accomplish this, within three months of the economy slipping clearly into recession, we will sell our remaining short-term income funds (mostly PIMCO Income by that time), transferring the money into these funds:

15% PIMCO Flexible Credit Income
10% Oaktree Specialty Lending Fund ETF

Shortly after we enter recession, these funds will likely give us a yield close to our 15% plus goal. Each is managed by the most accomplished investment firms in taking advantage of distressed debt opportunities, and each has spent the last several years getting ready to take advantage of what is now occurring in their markets.

For the last five years, I have planned to put at least a quarter of our money into distressed debt funds whenever those markets imploded. My expectation was that the combination of their high yields and price growth potential would lead to 20+% annualized return potential for the 5 years following a downturn.

From one perspective I was wrong. What I didn’t realize was that this is where the market’s problems would materialize first. I also didn’t realize the obvious, which is that the distressed debt opportunity appears whenever and wherever the big losses start to occur. In commercial real estate and corporate lending this is happening today.

For example, office buildings are down 45% in price, while many retail mortgages are also in trouble. Then we have corporate America writ large. Money which was once available through either the banks or, primarily, through our shadow banking system (dominated by insurance companies, hedge funds, large institutional firms, etc) is disappearing fast.

This was, of course, to be expected. Most of the large lenders just lost billions of dollars on their loans – especially in commercial real estate but likely spreading. Then we have PIMCO and Howard Marks at Oaktree – two investors who have some of the deepest pockets and have been preparing for exactly what’s now going on. This is the time when the best distressed debt investors make fortunes for their clients.

#4.
PIMCO Real Estate Flexible Credit. This fund mirrors the PIMCO Flexible Credit fund but is focused on real estate lending and special opportunities instead of corporate debt. Listening to their manager recently, I was struck by how the same types of opportunities are now available to PIMCO in real estate. Many office and retail building owners are beginning to get desperate to avoid losing their properties. As a result, PIMCO is now able to create unusually advantageous contracts to fund troubled projects using their enormous credit underwriting resources. In this case, all the advantage goes to PIMCO’s customers, i.e. you.

You could call our discussion thus far, “How to get 6% in income while having growth potential on 100% of your money.” This is how we’ll be describing our new Growth & Income portfolio. We plan to take full advantage of these four areas designed to grow when the economy enters recession and the markets come falling down. Plus, whether our accounts rise or fall on a given day, the portfolio will continue to generate its 6% in interest and dividends.

Income-Oriented Investment Strategies

With the increased interest rates and yields there are income producing portfolios that we are able to create that can produce stable and durable income. (Dividends and distributions can be monthly cash income or can be reinvested.)

• High Yielding Income

  * Designed to maximize income while managing volatility
  * Can utilize fixed income / bonds, cash producing real estate funds, infrastructure paying generous dividends.

• Conservative – Moderate Income

  * Low Volatility Fixed Income Funds that can produce an income with stability and longevity

• Guaranteed Income

  * Income generated though the strategic use of annuities.
  * Guarantee a specified amount of monthly/annual income that cannot be outlived.

Which should I choose?

If a person is retired and has enough money, most would prefer having that money as diversified as possible. This means I would recommend having both our Growth & Income, i.e. Tactical Allocation Portfolio, and then at least one income account. These accounts are tailored for each client based on their preferences and specific needs, so many clients have a modest amount in the high-income funds and most in our more conservative income funds, etc.

The good news is that each of our accounts is now paying either close to, or substantially more than, 6% annually. Whether you need the money for income or not, that’s our new “floor”.