PFFA Pays 10% With 41% Future Upside

If you are an income-focused investor, you likely feel that your investments have been left behind. The financial news covers the hot stocks such as Amazon and Tesla, which seem to set new record highs every day. Outside of the handful of top tech stocks, most investments have not recovered from the February and March stock market crash.

A market event occurred in March that devastated high-yield investment prices, and which I have not seen reported anywhere in the financial news media. I call it a “liquidity event” when the market in the various high-yield sectors was filled with sellers, not matched by investors willing to buy.

Over the last few years before the COVID-19 outbreak, a popular investment strategy was to leverage the yields in the different high-yield sectors. This strategy put investments dividend-paying sectors such as REITs, finance REITs, master limited partnerships (MLPs), infrastructure stocks, business development companies (BDCs), and preferred shares into leveraged portfolios to boost the income even higher.

Before the crash, there were dozens of ETFs and exchange-traded notes (ETNs), hundreds of closed-end funds (CEFs), and I suspect many private equity funds using leveraged high yield as their investment strategy.

When the stock market started to decline in reaction to the coronavirus effect on the economy, the liquidity event occurred. As share prices fell, all of these leveraged portfolios quickly became overleveraged. To protect the equity, the funds started to dump shares to pay down debt to reduce the leverage. Dumping the shares, caused share prices to fall, increasing leverage ratios, triggering more selling, resulting in further share price declines.

When the smoke cleared, with a matter of days, stocks in the high-yield sector had fallen by 60% to 90%. UBS, the sponsor of 2X leveraged ETNs, closed 17 funds over a ten-day period. These funds were sector focused on the high-yield groups listed above.

To give perspective, during the stock market crash, the major stock indexes declined by about 30%. The liquidity event for leveraged funds pushed the high yield sector down more than double the decline of the broader stock market.

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