Weekly Series: mREIT And BDC Recommendations (And Price Targets) As Of 12/10/2023
We aim to retain the same layout from week to week. The layout is carried over from last week.
This is one of those rare weeks where we have a modification in the layout. We’re testing an alternative layout.
The modification is moving parts where the view is “same as last week”.
It will be right after the last image. Why there? Because it’s pretty easy to find the last image while scrolling. I want the section to be easy for readers to find.
The objective here is to emphasize the sections where something changed.
Note: The paid version has several images. One of them is a chart of all our positions (showing precise allocations).
All readers deserve disclosures on positions. This doesn’t have precise charts, but it is a list of the shares we own.
CWMF's is long: RITM-D, GPMT-A, DX-C, EFC-A, RITM-C, EFC-B, PMT-C, PMT-B, CIM-B, AGNCP, CIM-D, RITM-B, RITM, SLRC, GPMT, RC.
Scott Kennedy is long: RITM, RC, SLRC, GPMT, ARCC, TSLX, FSK, RITM-D, MITT-B, MITT-C, GAINL, RCB, ECCC, ECCW.
Weekly Notes From CWMF
Sold: 310 shares of CCI. Still own 561. Current weight: 4.52%.
Purchased 147 shares of SBAC. Now own 503. Current weight: 8.52%.
Note: Both positions ending in .52% is just a coincidence. The shares of CCI we sold, and the shares of SBAC we purchased have a very similar total value. Around $36,600.
Not much going on in the sector over the last week. Most price changes were pretty modest. Some triggered downgrades. See Scott’s Notes about GAIN under “BDC Other Comments”.
I’ll be working on the Portfolio Update, which should be ready to go out within the next day or two. We’ve had so many articles lately that I didn’t want to push them too close together. The general part about existing positions was done a few days ago, but the time-sensitive part is prepared just before publishing. That’s the part where I use current prices to highlight some thoughts on various shares. Since it depends on current prices to be actionable, I need to write it just before publishing.
I will also be working on some updates to the preferred share targets. The substantial majority of those revisions should be pretty small. I would estimate (very roughly) that the substantial majority of adjustments will change targets by less than 2%. In other words, expect most adjustments to be less than the change on a typical ex-dividend date. Why do they need new adjustments?
Well, a sharp swing in interest rates can warrant adjustments. However, they also need adjustments because fixed-to-floating shares are now a bit closer to floating. That can trigger some minor adjustments.
Our Preferred Share Target Process:
I want to remind investors about our process for setting targets. There is no perfect way to set targets. Every method will include some weaknesses because the market is inefficient.
The simplest example is a scenario where an analyst knows share X is regularly overvalued to share Y. Pretend both shares offer yields very close to 9%. If an analyst could spot pricing failures, they might try to enhance their returns by an extra 2% to 6% over the course of a year by swapping back and forth based on relative valuation. This considers the ex-dividend date, but it doesn’t prioritize it. It’s just about getting good deals on swapping back and forth. This is useful for traders, but not as useful for investors who are committed to buying and hold. It still assists them in finding good entry prices, so they still get value. But they won’t be getting the extra returns from swapping shares.
For the ultra-long-term buy-and-hold investor, setting the targets using long-term projected cash flows adjusted for difference in risk rating is the best method.
For the highly-active trader, setting targets based on the expected difference in prices (factoring in the frequent market failures) would be better. This method would produce far more opportunities to capture small amounts of outperformance.
We could, theoretically, set two price targets based on both scenarios. However, that process would quite reasonably drive new investors to shout:
“Why are you creating two sets of price targets? You can’t tell investors to take both sides of a trade! What kind of stupid service is this?”
However, the two processes generally resulted in very similar targets before.
Prior to the Federal Reserve sending Treasury rates substantially higher, the market failures were primarily something we would almost exclusively spot in real-time. Those were still very actionable, but they were abrupt. It was along the lines of:
“This share just underperformed by 3% for the week, with 2% today. Looks like a great opportunity to swap in.”
We would use those opportunities to swap in. When shares are extremely similar, price movements should be extremely similar. If we spot them failing, that’s an opportunity.
Higher short-term rates resulted in far less efficient markets (at least for preferred shares). Failures in relative values can last for many months. Further, the disparity in valuation for comparable instruments reached levels that had not been seen since the pandemic (when liquidity failures drove some absurd pricing failures).
Consequently, we can’t stick exclusively to setting valuations based on discounted future cash flows. However, discounting future cash flows is still the most important factor in targets by a significant margin.
Our current process focuses on discounted cash flows, but it also includes some modest adjustments based on which shares we expect the market to overvalue. This makes it easier to better identify trading opportunities, which has contributed nicely to our returns.
I’m not going into explicit details on how we determine which shares the market is most likely to overvalue. I don’t want to risk that information reaching competitors.
Weekly Notes From Scott
Positions: No purchased or sold positions.
BDC Weekly Change: Continuing the recent, general trend, NAVs were relatively unchanged - very slightly increased. Spreads remained relatively unchanged - very slightly tightened.
BDC Other Comments: Similar to the prior 8 weeks, muted volatility in high yield/speculative-grade debt this week. Regarding weekly recommendation changes (mainly due to stock price and projected NAV changes), 4 downgrades and 1 upgrade occurred. This was mainly due to weekly stock price increases outpacing projected NAV changes. OCSL, GAIN, MAIN, and TPVG moved from APPROPRIATELY VALUED/HOLD to OVERVALUED/SELL. All 4 changes were due to valuation. GAIN’s $0.88 per share special periodic dividend accrued this past week (stock price and NAV notably “reset” lower). With the continued, general market rally, valuations within the BDC sector are *starting* to become a bit steep in most names. Just something to consider at this point.
Hey readers. CWMF butting in. For the public release, I’m putting the membership wall here. Scott’s about to preview a potential change in his positions. It wouldn’t be fair to our paid members to include that in the public release.