CMOs (Collateralized Mortgage Obligations)
High quality loans backed by mortgage collateral and US Government payments represent a good portion of our investments. We take the time to sift through thousands of offerings, and invest in securities that provide excellent risk-adjusted returns. Depending on the investment vehicle, we find principle and interest, principle-only, or interest-only securities that serve as a hedge to more traditional fixed income securities. In periods of low interest rates as we find ourselves in now, CMO’s are particularly compelling as any eventual interest rate increases will impel existing mortgagees to stay in their lower-rate mortgages and give investors higher retention rates with lower rates of refinancings.
In between the risk of common stocks and the low rates of corporate bonds lies the middle of the road Preferred Stock asset class. Annual yields can often be in the double digits, but typically in the high single digits. Our niche is owning preferreds that pay a handsome dividend which are cushioned by enough cash flow to also pay dividends on the issuers common stock. In the development of weakened cash flows, the common stock holders are first vulnerable to dividend reductions leaving the preferreds untouched. If adverse conditions persist, we have enough time to exit the investment before the preferreds are affected. We look for long-term cash flow predictability generally through companies in sectors with extended contracts such as real estate or shipping.