This Christmas Present for Investors Has an Expiration Date By Stephen Hester, Chief Analyst, Wide Moat Reseach Being a due diligence officer for a giant broker/dealer has its perks. That's especially true if you find solving the mysteries of Wall Street interesting like I do. I traveled to places like Manhattan and Chicago to meet with top investment managers including Blackstone (BX), Apollo Global Management (APO), and KKR (KKR). Early in my career, I admit it was intimidating. But over time, I learned how to extract as much information from these companies as possible. It was my job to decide which investment opportunities were best for the firm's investors. That included private equity, private credit, real estate, hedge funds, infrastructure, and energy investments. And not just in the U.S., but all around the world. At first, I found the individual investments the most fascinating. But I quickly realized that wasn't the key to these legendary managers' success. A single stock recommendation can make you money once. But understanding how a truly skilled stock picker thinks can make you money for a lifetime. Today, I'm going to share one of the inside tactics that Wall Street taught me. And how you can apply it to your portfolio. Run Toward Chaos I want you to think back to the pandemic panic in March 2020. Or, if you've been in the game as long as I have, March 2009. That's when the S&P 500 Index bottomed out during the Great Recession. How were you feeling about the market? How about your family and friends? Most people say a mix of despair, fear, and hopelessness. It's only human nature to feel that way during a full-blown market crash. But that's not how Wall Street thinks, and it's not how you should either. I learned Wall Street runs toward chaos, not away from it. Some investors believe it's because these firms are reckless or only risking other people's money. Wall Street investment managers like the three I listed earlier earn a huge portion of their income through what are called performance fees. Source: Blackstone Group Q3 2024 Earnings Presentation Blackstone, for example, ended the last quarter with $7 billion in accrued performance fee revenue. That's more than three times Blackstone's entire year-to-date net income (profits) of $2.2 billion. Those fees are paid only if they meet performance targets that they and their investors agreed to. Blackstone and their peers have a tower of cash riding on their investments doing well. And they really like money. That's why they tread carefully and take smart risks. When asset classes become distressed, like stocks were during the two most recent crashes, Wall Street takes notice. The reason is simple: History shows that these troubled areas often have the greatest upside. It requires a lot of hard work and skill to separate the bad apples in a beaten-down sector from the good. But when a whole sector is thrown into the trash out of frustration, Wall Street starts digging. I believe that's exactly what's happening with many high-yield investments right now. Take the VanEck BDC Income Fund (BIZD). It tracks business development companies ("BDCs"). It's down over the past 12 months and yields a whopping 11%. VanEck Mortgage REIT Income Fund (MORT) is similar but tracks mortgage-based real estate investment trusts ("REITs"). It's down over 15% since September 2024 and yields an even higher 11.6%. Now, I'm not recommending either of these exchange-traded funds ("ETFs"). But I do believe there are extremely attractive investments in both of their portfolios (and many I'd never own). Certain corporate bonds are also very appealing. These had 4% to 5% yields during much of 2024. Just recently, they've sold off and now generate much higher income. We can thank fears around interest rates and inflation for all of it. 10-Year Treasury Rate – Last Five Years Source: Macrotrends It's crystal clear when you look at the 10-year Treasury bond. It's the benchmark interest rate for the whole world. As shown above, it's quietly climbed back to post-pandemic highs. Add uncertainty about the Fed's plan for 2025 and all sorts of income investments are trading at depressed levels. At Wide Moat Research, we try to learn from the best, and that includes top Wall Street managers. It helps us know where to look for once-in-a-decade opportunities. The same kind that I believe we are seeing in many parts of the high-yield market today. But these conditions won't last forever… The Expiration Date From time to time, we all have that uneasy feeling about a sector or industry. Many years ago, it happened to me with oil. I read so much bearish news that it caused me to sell my ExxonMobil (XOM) stock at a rock-bottom price. If I'd held on, I would have had a quick double in one of the safest companies on earth. Instead, I should have looked for even more companies like Exxon trading at deep discounts to fair value. The overwhelming bearish takes were a sign to buy, not sell. But I was missing two things. The first was I hadn't learned the lesson one-on-one from Wall Street. The second is I didn't have the expertise to apply it. All of our strategies at Wide Moat Research embody this approach. Whenever you feel that the news just couldn't get worse for an asset class, don't run. Dig deeper. Right now, high-yielding BDCs and related assets have been buffeted by the uncertainties around interest rates. This has been going on for a long time, but it can't go on forever. While long-term rates have been ticking up lately, the Federal Reserve is still in "easing mode." The market is applying an 87.5% probability of one or more cuts this year with the consensus being 2 to 3. I can't tell you precisely when conditions will improve for these high-yielding assets, but they will… sooner or later. For many, looking at this area of the market gives them a sick feeling in their stomach. But I couldn't be more excited. Premium members to our High-Yield Advisor service can expect to receive actionable recommendations on these assets in the weeks and months ahead. Regards, Stephen Hester
Chief Analyst, Wide Moat Reseach | 