My favorite dividend strategy

[daytripper]

My favorite dividend strategy is as follows…

Buy TLT AND buy HYG at a ratio of 1 to 3

For example, buy 100 shares of TLT and buy 300 shares of HYG

TLT is a long term government bond fund and HYG is a high yield corporate bond fund

This will give you a relatively stable position with a slight upward bias

The position delta with this ratio of 1 to 3 is usually just slightly positive – about .17
As of this time, my position delta for HYG is +7.35 and for TLT is -7.18
The ratio of 1 to 3 is critical to get the stable position

TLT and HYG usually move in opposite directions.
When the market goes down, TLT goes up and HYG goes down
When the market goes up, TLT goes down and HYG goes up
You can go back to the market crash in 2008 and see how TLT move up while HYG moved down

The goal here is to collect a good monthly dividend and have some protection on the downside

Although the position has a slight upward bias, and I am up money, I do not touch the core position

I just let this position sit for the long term and collect the monthly dividends

TLT yield is about 3% - HYG yield is about 6%
This should give you a blended yield of about 5%

Any thoughts or comments?

[Alex in Virginia]

Well, it does not sound like you are talking about dividends at all. Both your positions are in bonds, which pay interest not dividends.

Your idea sounds OK. I don't do funds though. I buy individual stocks and bonds. Ever try anything like your strategy with specific company issues?

Alex in Virginia

[karluk]

I am certainly not going to start advocating a portfolio consisting of 25% TLT and 75% HYG, but I will say that admire the outside-the-box thinking involved in coming up with the idea in the first place. Just eyeballing the graph of the two securities makes it clear that there is considerable negative correlation between their price movements.

The reason for this is not hard to discover - plot a graph of HYG vs the S&P 500 index, ^GSPC, and you will see that the price of high yield bonds has closely tracked the stock market in recent years. So you have succeeded in building a portfolio with risk characteristics that are very similar to a 75% stock, 25% long term bond mixture. Just as one would expect the 75% stock, 25% bond mixture to be less risky than holding 100% stocks, so too would one expect the 75% HYG, 25% TLT mixture to be less risky than holding 100% HYG.

The question is whether you're any better off chasing yields by holding 75% HYG instead of 75% in a diversivied portfolio of commond stocks. I seriously doubt it. My guess is that your portfolio has just as much risk as a 75% stock, 25% long term bond portfolio, but less upside potential.

[FIRE'd@51]

In a period of rising interest rates both TLT and HYG can go down together. The duration of TLT is about 17 and the duration of HYG is about 3.8, so your blended duration is about 7.

[daytripper]

They are both ETFs and contain baskets of treasury and corporate bonds
Both the TLT ETF and HYG ETF post a monthly dividend, usually about the 5th of the month

Personally I don’t buy individual bonds

No, I do not do this with stocks.
That is because I don’t think I could find individual stocks or even baskets of stocks that have as good a negative correlation as TLT and HYG to provide a stable position

My goal here is to set up a low risk strategy that pays a good dividend
I have other accounts that I do riskier trades in such as options, but with this account I don’t was a lot of market risk

The negative correlation with the 1 to 3 ratio is essential to providing a stable base while collecting about a 5% dividend. It has held up well during the market crash, euro crisis, sequestration etc..

It remains to be seen what happens to these ETFs and the market in general when interest rates start to rise

If I ever see this correlation break down, that will be my signal to close the position
Both TLT and HYG are very liquid, they average about 7 million shares / 3 million shares traded daily and the bid/ask spread is usually a penny wide. So I can close these positions in an instant

[pb4uski]

If the economic recovery continues and interest rates increase 300bps over a few years wouldn't you take a licking?

[brewer12345]

The high yield market scares the crap out of me at the moment. Example:

I just saw a structurally subordinated Caa-rated bond about to be issued that had no collateral coverage, PIK/toggle structure (at the issuer's option they can give you more bonds rather than pay cash interest, like an option ARM), and proceeds used to pay the shareholders cash. Haven't seen the covenant package on that deal, but given the generally sloppy covenants on recent deals I would not be surprised to see a bunch of holes in it.

[braumeister]

Sounds like the way Argentina funds its government operations.

[perrytime]

A MS graph of TLT, HYG, TEGBX for 5 years shows the first 2 more volitile, about same end return 50% total, but if dividends are harvested, Yahoo graphs shows HYG down 5%, TLT up 35%, and TEGBX up 15%, So which is better is hard for me to see. And changing time frame changes results. I guess my point is less volitilty and similar returns can be had.