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Building A $100,000 High-Yield Income Portfolio From Scratch: Linn Energy Causes Havoc

  • My $100,000 high-yield income portfolio took a substantial hit over the last few months.
  • Linn Energy in particular caused real damage to the portfolio.
  • Linn Energy also announced that it would suspend its distribution at the end of September.
  • All income stocks held in the income portfolio contracted in value.
  • A new position will soon be added to the HYIP.

Six months ago I began the process of building a $100,000 high-yield income portfolio from scratch. As I explained here, the goal of the high-yield income portfolio, or HYIP, is to generate high income by accepting a high degree of risk. Since I intend to invest in high-yield income stocks in the business development company sector, among other sectors, the potential for capital appreciation is only a secondary goal. Why? Because most companies with high dividend yields have to pay out most of their earnings in the form of dividends/distributions. As a result, the upside is, with exceptions, generally limited.

New Residential

When I wrote the first performance update for the HYIP, the portfolio performance was overly positively influences by the outperformance of New Residential Investment Corp. (NYSE:NRZ). Thanks to the announced acquisition of Home Loan Servicing Solutions, Ltd. (NASDAQ:HLSS), New Residential's stock surged and reached a new 52-week high at $17.91 on May 19, 2015. New Residential eventually surrendered most of its gains in the second and third quarter.

The performance update I wrote at the time carried the proper title "The $100,000 High-Yield Income Portfolio Is Off To A Good Start... But Let's Not Get Cocky", and contained the following two paragraphs:

I think one of the biggest traps in dividend investing, or in investing in general, is that investors don't stick with their investment strategy. Too many investors chase what's in demand today, but lack the confidence and mental resilience to hold onto their investments when times get tough and the market tells them that they are wrong.

Though the HYIP is off to a good start, thanks to New Residential, it is important to be honest and to recognize that "luck" can have a great deal of influence on your investment returns. New Residential's strong price returns work now in my favor, but I am NOT going to obsess over short-term returns. The idea behind the HYIP is to build a nest egg that can throw off handsome amounts of cash while I am taking advantage of the power of compounding.

As it turns out, momentum can work both ways, and I am glad I didn't get carried away with the good portfolio performance in the April update. The last six months were not the best time for income stocks with many high income investment vehicles losing a LOT of value. Most BDCs, REITs and energy companies have performed very poorly over the last few months.

And so did the HYIP. All three companies currently part of the HYIP took a serious hit, but as I wrote in the last performance update, my portfolio is not a short-term focused trading portfolio. So Yes, I am just going to sit out the turbulence and focus on adding other dividend paying stocks over time.

What hurt my portfolio performance the most was the collapse in energy-related income stocks, namely Linn Energy (NASDAQ:LINE). The energy company announced in July that it would suspend distributions in light of slumping crude oil prices. As a result, Linn Energy fell off a cliff and now trades at less than $4.00 per share. The speedy decline in Linn Energy's valuation was nothing short of breathtaking.

Right now, Linn Energy is the loss leader in my portfolio. Despite the hit I have taken, I am not going to sell Linn Energy at bargain basement prices. Linn Energy has essentially become an option on the oil price -- nothing more and nothing less. in my opinion, there is no reason why Linn Energy's units couldn't return to $10-15 if oil prices recover.

The second position in the portfolio that declined in value was Prospect Capital (NASDAQ:PSEC). Despite the negative investor sentiment regarding the business development company, Prospect Capital produced two consecutive quarters with a stable net asset value per share. Especially fourth quarter results, which were defined by a penny increase in the company's NAV, helped turn things around for Prospect Capital. I think the company is able to maintain its current dividend payout of $0.08333 per share. It is worth staying the course here.

Portfolio overview

Source: Achilles Research

Portfolio performance

The current portfolio performance does not reflect the true long-term return potential of a high-yield income portfolio for two reasons.

1. The last six months weren't kind to income stocks, but New Residential and Prospect Capital retain income potential. Prospect Capital still trades at an excessive ~24% discount to NAV, but continues to report a stable asset base and buys back its own shares.

2. The weak performance of the HYIP is also driven by my unique portfolio construction process. Right now, the HYIP comprises of only three positions, and that's not exactly what one would describe as "diversified". More dividend stocks will be added to the HYIP over time, which will lead to better portfolio returns and lower portfolio risk.

After a good start thanks to New Residential, the HYIP took a substantial hit due to a material consolidation in income names that negatively affected all three stocks in the portfolio. Linn Energy's distribution suspension definitely hurts and the company, at least for now, is a big loser in the portfolio.

Despite the bad performance of the portfolio and the stock market in recent weeks, there is no reason for throwing in the sponge just yet; "investing is a marathon, and not a sprint". I am going to buy more dividend paying stocks over the next 18 months for the HYIP, many of which will help to decrease portfolio risk.