Co-authored by Treading Softly.
Throughout 2020 to 2023, the stock market has seen its fair share of tumultuous times. From the COVID-induced crash to the recent bear market, it has been an unpredictable journey. While some may boast about the market’s overall performance, many investors are left pondering uneven results in their portfolios. This is not without reason. The astounding market surge has largely been driven by a select few companies, leaving other stocks lagging and holding back overall portfolio performance.
Taking a historical perspective, a five-year overview of the S&P 500 reveals a marked disparity between an equal-weighted portfolio of the entire index and one that mirrors the index’s exact weighting.
Market efficiency has always been a hotly debated topic. However, in the short term, it is the tendency of emotions and overreactions to sway the markets, consequently leading to inflated values for some companies and oversold positions for others. This creates opportunities, especially for income investors, during unpopular market phases.
In light of this, we are going to dive into two exceptional opportunities that have been overlooked and undervalued. They have not been part of the “in crowd” in recent years but are currently trading at attractive valuations and high yields.
Pick #1: HQH – Yield 9.1%
abrdn Healthcare Investors (HQH) is a Closed-End Fund (CEF) specializing in investments in the healthcare sector. The healthcare industry boasts robust fundamentals owing to the perennial demand for healthcare services, which is set to increase with an aging and growing population. Nevertheless, it is a sector prone to political upheaval, making it subject to significant regulatory changes that may challenge the adaptability of healthcare companies.
Against this backdrop, HQH has demonstrated superior performance compared to the S&P 500 and the S&P 500 Healthcare sector over the long term.
However, despite healthcare’s historic underperformance in recent years, largely driven by companies readjusting from their COVID-introduced market peaks, HQH presents an enticing investment prospect. The prevailing negative sentiment among investors has driven HQH to trade at a significant discount to its Net Asset Value (NAV) – a discount that has historically been observed during recessions.
HQH’s longevity, dating back to the 1980s, speaks volumes. Its resilient performance through various market cycles, coupled with consistent distributions for investors, is exemplary. One of its key strategies is the variable distribution policy, through which HQH pays out 2% of its NAV each quarter, ensuring that distributions align with NAV movements. This approach allows NAV to recover during downturns and provides higher returns during upswings.
Hence, given the current steep discount to NAV, HQH not only offers an attractive yield but also an opportunity to capitalize on potential capital appreciation.
Pick 2: DX – Yield 12.3%
Dynex Capital, Inc. (DX) is a mortgage Real Estate Investment Trust (REIT) focused on agency Mortgage-Backed Securities (MBS) guaranteed by Fannie Mae and Freddie Mac. While DX operates in a similar space to peers AGNC Investment (AGNC) and Annaly Capital Management (NLY), its approach sets it apart.
DX, like other agency mortgage REITs, is not exposed to credit risk but faces interest rate risk due to its reliance on short-term borrowing to fund long-term assets, especially in an environment of inverted yield curves. However, DX employs a distinct approach to managing this risk, setting it apart from its peers.
Unlike AGNC and NLY, which heavily rely on cash flow hedges like interest rate swaps, DX takes a different route to hedge its interest rate risk. This unique approach stands as a testament to DX’s innovative risk management practices.