What looks like a good deal often turns out not to be. With interest rates and bond yields at their lowest in recent years, many investors have invested money in stocks that offer not only high returns but the prospect of capital gains as well. Widespread dividend cuts earlier this year dashed those hopes, providing a costly lesson that if it sounds too good to be true, it probably is. High yielding stocks come with hidden risks, but there are exceptions, especially when, like today, investors are cautious.
Many real estate funds, for example, were not getting the benefit of the doubt, but the decision to ICG Longbow (LSE: LBOW) initiating an orderly liquidation, resulting in a 16% rise in the share price, shows that the market is not always right. Stocks are now earning 7% and trading at a 13% discount to net asset value (NAV), so they still look attractive.
Invest in home loans
Mortgages UK (LSE: UKML) Also invests in real estate backed loans, so its income is not sensitive to the capital value of the underlying property, but only to the creditworthiness of the borrower and the security of the loan. Launched in 2015, it is managed by Twentyfour Asset Management, a boutique firm specializing in fixed interest, and has Â£ 186million of net assets invested in residential mortgages. The portfolio consists of six pools with a total of Â£ 1.65bn in mortgage loans, one quarter owner-occupied with the rest rental.
These pools were formed by lenders, such as the Coventry Building Society, and then âsecuritizedâ with low cost loans. The remaining Â£ 172m (there is Â£ 14m in cash) gives UKML a return close to 10%, allowing it to aim for a total return of 7-10% per year after fees.
Obviously the portfolio is heavily leveraged, but the average mortgage size is less than Â£ 200,000, the average loan-to-value ratio is less than 70%, the average interest rate is 2.7% and less 0.5% of mortgages last three months or more. arrears. The number of paid holidays is declining and Nationwide reported that house prices rose 5% per year in September, the highest growth rate in four years. Despite this, stocks at 67p are earning 6.7% and are trading at a 16% discount to net asset value. Yet a few months ago M&G, on behalf of one of its funds, made an offer of 67 pence per share, which was later increased to 70 pence.
M & G’s fixed income team is highly regarded. The offer was therefore a powerful endorsement of the portfolio outlook and its rejection by the UKML board implies that they agree. UKML also states that “the fair value (ie a net asset value of 80 pence per share) should not represent a mere realizable value as the portfolios will be held to maturity”. The realizable value is listed at 95 pence per share, so the shares always look cheap.
A Reit ready for growth
Actions of GCP Student Living (LSE: DIGS), a real estate investment trust (REIT), trades at a discount of 17.5% from net asset value. Management expects to receive only 62% of budgeted revenue this academic year compared to 82% in 2019-2020 and a five-year average of 94%. The structural shortage of student accommodation, particularly in London, which accounts for 80% of DIGS assets, supports long-term rental prospects but the short-term decline in income has led to a lower dividend. Expense income expected this year is still expected to be almost double the funding costs, but that would only leave enough to cover a dividend of around 2p.
Restoring the 6.2p dividend would imply a 4.4% return and, perhaps, bring stocks back to the premium they were trading at before the pandemic. With mass immunization just a few months away, the outlook for student housing providers has improved. DIGS shares still look attractive.