Following a Billionaire’s Playbook for Triple-Digit Returns on an “Untouchable” Asset

Some of the smartest and most successful investors in the world know something most people don’t: Risk isn’t something you must avoid to make income safely.

Not only is it impossible, but avoiding risk entirely means missing out on the best profit opportunities. You just have to make sure you’re weighing that risk intelligently and always keeping the facts front and center.

The last few weeks have kicked up a lot of dust across the market. And while that’s causing volatility… it’s also creating opportunity.

In today’s issue, Chief Analyst Adam Galas will highlight a Fortress Portfolio recommendation that’s trading at a huge discount.

But when we look at the facts, we see it has plenty of cash on its balance sheet, a healthy dividend, strong growth prospects… and the stamp of approval from four individuals who are worth $87 billion combined.

This “untouchable” asset is undervalued today, but likely won’t be for long. Adam will lay out the case for how it could triple your money in the next few years.

Then he’ll update you on the ongoing turmoil in the markets, lay out how it affects all the financial stocks in our model portfolio, and share their minimal exposure to future risk.

Our buy-and-hold forever strategy at Fortress Portfolio means we must be ready for all kinds of market environments. So instead of being fearful, we’ll pursue the best deep-value opportunities, knowing these best-in-class companies have withstood the test of time and will continue doing so in the future.

Read all about today’s opportunity below…

The second half of 2021 was one of the bleakest times in history for energy stocks.

The world was starting to bounce back from COVID lockdowns. That meant increased demand for energy to support the rapidly recovering economy. 

Ahead of its invasion of Ukraine in February 2022, Russia had started withholding its oil supply to Europe. 

Supply was tight. And according to the International Energy Agency (IEA), gas, coal, and electricity prices hit their highest levels in decades.

But among all the alarm surrounding the sector, one man smelled opportunity...

In September 2021, he bought a $600 million Mexican oil company called Vista Energy (VIST). And that investment paid off…

Today, Vista is up 340%, with 168% annualized returns. For comparison, the S&P is down 5%.

And that wasn’t the only move this investor made during that time. He was eyeing other sectors, as well.

That same month, he bought Vale (VALE), one of the world’s largest miners.

At the time, miners were deeply out of favor. No one was even looking at commodities or precious metals. Not when tech stocks were having a standout year.

But while tech stocks have cratered… Less than two years later, Vale is up 190%, delivering 103% annual returns.

And in March 2021, he targeted another sector facing a crisis.

You might remember that’s when we had a global shortage of semiconductor chips, the “brains” behind nearly every major electronic device we use. 

Everyone from Apple to Ford to Microsoft was facing delays and losses. They all needed these computer chips to produce their iPhones, trucks, and Xboxes.

Again, this man saw an opportunity to profit. So he bought Super Micro Computer (SMCI), which makes computer components for server farms.

Today, Super Micro Computer is up 202%. That’s a 74% annual return in two years.

When someone can repeatedly make profits from unfavored sectors – especially when the broad market is flat or down – we want to pay attention.

That’s why today, I’ll tell you about the strategy of one of the most successful investors on Wall Street you’ve likely never heard of.

He’s such a force, even legendary investor Warren Buffett says his memos are the first thing he reads.

His name is Howard Marks.

In 1995, he co-founded asset management firm Oaktree Capital. Since then, his investment strategy has returned 11,000%. Meaning if you’d invested $10,000 with Marks in 1995, you’d be a millionaire today.

Today, Howard Marks manages $8.4 billion of investor capital and is worth $2.2 billion himself. And how he got there might surprise you…

He started as a bond investor, one of the most boring investments you can imagine.

But he figured out how to buy “untouchable” bonds no one else wanted… and turn a profit. And that’s become the key to his success.

You see, Marks specialized in high-yield credit products. He bought bonds other investors deemed “junk” and wouldn’t touch with a ten-foot pole.

You might think distressed assets like “junk” bonds are full of risk. But Marks’ approach to risk is much like our own.

He believes if the price is low enough and the margin of safety high enough… then a correctly sized position in deep-value stocks or bonds can generate life-changing and retirement-building wealth.

Mark’s philosophy is to seek a “high batting average over home runs.” He doesn’t try for grand slams. He’s not out to find the next Tesla; he’s out to find the next discounted opportunity that can make you rich… safely.

In other words, he can achieve maximum income and returns with minimum risk by making smart, calculated investments.

At Fortress Portfolio, that mindset is music to our ears.

We’ve used years of testing and research to develop a strategy that will allow investors to withstand market volatility, recessions, record-high inflation, interest rate hikes, and any other economic setback.

And we do it in a similar way to Howard Marks – by finding undervalued plays that are overlooked, but carry a high degree of safety based on our metrics.

Today, I’ll highlight one of the plays in our Fortress Portfolio that represents a perfect setup just like this. And better yet, it’s a favorite of Howard Marks himself…

In early 2021, Marks started buying a hidden gem real estate investment trust (REIT) no one wanted. He picked up shares then… and has continued buying it ever since – despite it trading at a lower level now.

Today, Marks owns almost 2 million shares of this 6%-yielding REIT, and he’s not alone.

Hedge fund billionaire legends like Jim Simons, Paul Tudor Jones, and Ray Dalio also own it.

Collectively, these four hedge fund titans are worth $87 billion. They are some of the most respected and widely read names in finance… And they all own this Fortress REIT. In fact, they were all buying more of it in Q4 2022.

In this month’s issue, I’ll show you why these billionaires love this REIT, why this selloff is an overreaction, and how it’s actually presenting us with a great opportunity today.

If you haven’t already reached your 4.4% Fortress Portfolio allocation for this play, now is a great time to enter or add to your position.

From today’s levels, it represents the chance to make 196% – or triple – returns in the next five years.

So let’s follow in the footsteps of one of the greatest investors of our time and lay out the case for this “untouchable” REIT.

At Fortress Portfolio, we aim to buy and hold forever (or until the thesis breaks). From there, we collect dividends and watch our income grow through all market conditions.

Which is why it’s important to take an initial position at a good value.

We strive to buy $1 in value for $0.75 that grows steadily over time and capture superior returns through yield, growth, and valuation returning to normal.

And that’s the kind of potential we have with this month's top recommendation, Kilroy Realty (KRC).

Kilroy is an office space real estate investment trust (REIT). As a refresher, REITs own or finance real estate assets and pay out at least 90% of their taxable income to shareholders in the form of dividends.

They’re among our favorite ways to earn reliable income, backed by hard assets.

Now, not all REITs were created the same or function in the same sectors. And right now, Kilroy is being punished for the sector it operates in.

Why?

Because the work-from-home trend accelerated by a global pandemic has made the future of office space questionable for many investors.   

Today, Kilroy is 55% undervalued, trading at 8 times cash flow. Based on our calculations, that means Kilroy’s stock is priced for negative 1% growth.

But we – and the four billionaires I mentioned above – know better. 

Kilroy is growing. Granted, its post-pandemic growth rate has fallen to about 2%. But this REIT is priced as if it was on death’s door. That’s an overreaction, and one we can take advantage of.  

I’ll tell you why in a moment. But first, I’ll tell you more about Kilroy’s business and what sets it apart from other REITs in its sector.

Kilroy was founded in 1947 and became one of America's first REITs when Congress created that asset class in 1960.

Kilroy has survived and thrived through:

This is a company built to last.

Now, when you hear office space, you probably think of rows of soul-sucking cubicles at companies like IBM.

You don't think of this.

Source: Kilroy Investor Presentation

Kilroy's office buildings include apartments, gym facilities, retail space, and restaurants.

Its average office building is 11 years old, while the industry average is 34 years old.

In fact, Kilroy's properties are some of the newest in any REIT sector (with data centers as the youngest at around 9 years on average, and triple-net lease REITs – like Walgreens – an average of 44 years old).

Its maintenance costs are lower than other office space REITs, and its amenities better. That’s why Kilroy’s tenants are some of the world's most profitable and thriving companies.

For example, its top tenants include such world-beating blue-chips as Amazon, Microsoft, and Adobe.

In real estate, it's all about location, location, location. And here are where Kilroy's 115 office buildings, totaling 15 million square feet of rentable space, are located.

31% of Kilroy's tenants are investment grade (BBB- or better credit rating), which is tied for the highest in the industry.

What happens when you combine the newest buildings featuring multiple amenities and fourth-lowest maintenance cost operations with Kilroy's large economies of scale? 72% operating margins, the highest in the industry.

Kilroy’s 20% free cash flow margins are almost as good as Apple's. For every $1 that comes in the door, 20 cents drop straight to the bottom line.

Its occupancy is 92%, the fourth highest in the industry. In LA and San Francisco, the industry occupancy rate is 80% on average. But as you can see, Kilroy is far from average.

How are Kilroy's buildings still 92% full despite the work-from-trend? Because companies want workers to come back. And now that we're likely headed for recession, they will have the leverage to make them do so.

Another reason Kilroy has such strong occupancy is its rents are 12% below market average. Not just are its customers getting a good deal, but when the recession ends, it will have a built-in way to boost revenue per square foot and drive modest but steady growth.

That's why companies haven't been canceling leases. Kilroy's revenue grew 9% in Q4 2022, and cash flow per share grew 11%. For the full year of 2022, its overall profits grew 7%.

Does this sound like a dying company that should be trading at a 55% historical discount and priced for zero growth? 

And Kilroy isn’t sitting still. It’s investing to diversify and improve its business even more… And it’s targeting some of the world's most advanced research labs, with drug makers and research universities as tenants.

One benefit of these kinds of tenants is they can’t work from home. Medical researchers need the million-dollar equipment that can’t be moved around easily out of their labs. This guarantees the need for Kilroy’s office spaces.  

Now that we know Kilroy is one of the world's best office property REITs, we’re also reassured its dividend is likely safe in this and all future recessions.

That attractive 6% yield has grown for seven consecutive years, including through the Pandemic. And the payout ratio is just 61%. That compares to 90%, which rating agencies classify as safe.

(This "safe" payout ratio threshold is relatively high and may not seem sustainable, but that’s common with REITs. When you see a payout ratio above 100% – which is not unheard of – that means a company is paying out more in dividends than it’s making in earnings or rent. We like to see a more manageable, lower payout ratio. That means the company is also reinvesting in itself and won’t deplete its coffers trying to attract income investors.)

Speaking of rating agencies, Kilroy is rated BBB stable. According to S&P, that means it has a 7.5% bankruptcy risk over the next 30 years.

Now, I’ve been talking about an upcoming mild recession in 2023 in my video updates and in these monthly issues.

If we do hit that, here’s what you need to know about Kilroy:

Just 8% of its leases expire this year. And just $6 million worth of its debt matures in 2023.

Meanwhile, it has $1.7 billion in cash and short-term borrowing capacity compared to annual growth spending of $100 million and annual dividend costs of $253 million per year.

And if the recession lasts into 2024… Kilroy has just $12 million total in debt maturing in 2023 and 2024.

Because of its strong prospects and resilience to potential market turbulence, Kilroy’s management is confident they can return growth to historical post-Great Financial Crisis rates of 5% to 6%.

With that estimate, what's the bottom line for Kilroy?

Here are the total returns you could make if KRC grows as expected and returns to historical fair value of 19 times cash flow in the coming years...

Buying Kilroy today gives you the chance to triple your money in five years… with a 1 in 12 chance of losing your investment according to credit rating agencies. Now that's what I call an attractive reward/risk ratio.

Now, there’s no risk-free investment in the world. So we want to lay out what could potentially go wrong with our thesis on Kilroy.

Management expects stable occupancy in 2023 and about 1% growth due to the recession. And it expects the occupancy rate to remain stable and grow slightly to about 92% over the next 10 years.

Here are the expected growth rates for the next few years:

But there are a couple of things to look out for that could disrupt this projection.

A prolonged tech recession could cause occupancy to dip for several years.

And if work from home proves more popular than expected, then Kilroy might not be able to return to its historical 5% to 6% growth rate.

What if Kilroy doesn’t return to 5% to 6% growth and only grows at 2% forever? Then its historical market-determined fair value is about 17.2X its cash flow.

In that case, these are the returns investors can potentially expect.

If Kilroy only grows at 2% forever, then in 10 years, once its valuation returns to normal, you could expect about 6% yield + 2% growth + 6% valuation boost = 14% long-term returns.

For context, for the last 37 years, the Nasdaq has been the best-performing index. And it delivered 13.5% annual returns.

So this slowed growth would already put Kilroy on par with those results.

Another thing to be aware of… Kilroy’s debt levels are also slightly above rating guidelines at 6.2X debt/cash flow for 2023. Rating agencies want to see them stable at six or less.

That means Kilroy could face a credit downgrade and, thus, higher borrowing costs if we get a severe recession because credit markets would become more risk averse.

If the job market gets too tight, workers will continue to have leverage, and Kilroy could see occupancy decline, slowing growth, or even turning it negative.

As always, we’ll monitor this position closely and alert you if it breaks our investment thesis or any action is needed.

Keeping the potential risks in mind, we’re still confident holding Kilroy in our Fortress Portfolio.

It offers a safe, juicy 6% yield. We stand to make nearly 200% gains in the next five years. And even if it grows on the lower end of the projected scale, we still have a chance for triple-digit gains.

That’s why we added it to our Fortress Portfolio when we launched on January 12 this year. Since then, we’re down around 27% on the position as the entire market has been whipped around by the ongoing banking drama.

But for the reasons we laid out above, that only makes the opportunity today more enticing.  

(Now, it’s important to note that if we hit our 30% hard stop, we’ll reassess the position entirely and let you know if it still makes good investment sense.)

Overall, the opportunity with Kilroy showcases the power of high-yield blue-chip investing.

Howard Marks didn’t make his fortune – giving investors the chance to turn $10,000 into $1.1 million – from investing in the high-flying stocks of the day.

He sought out the beaten-down “untouchable” stocks like Kilroy. And still kept a clear eye on risk management and deep-value income investing. Which is exactly what we’re doing today.

Again, if you already hold a position in Kilroy, we don’t suggest over-allocating beyond our recommended amounts.

But if you haven’t yet, take advantage of today’s setup to earn double- or triple-digit returns from blue-chip bargains hiding in plain sight. All while earning 3.5 times the market's yield that's expected to keep growing every year for the foreseeable future.

Action to Take: Buy Kilroy Buy-up-to Price: $73.69 Position Sizing: 4.4% of your Fortress Portfolio. Or 2.5% to 5% in an individual portfolio. Risk Management: 30% hard stop loss ($26.76 for our tracking purposes)

If you’ve been following along with my video updates – especially from this week and the previous week – you’ll know the current banking crisis is something I’ve been tracking closely.

In this economic update, I’ll share some of the latest developments.

The reason I share these is because while our outlook is over the long term, we want to ensure you know what’s going on regarding short-term market moves… and the overall economy.

This will tell us when we can take advantage of buying opportunities or batten down the hatches.

And, of course, every step of the way, we’ll keep you informed of if any of these will affect our Fortress Portfolio holdings or returns.

Please note: This is a fast-moving situation, so my weekly video updates are where you’ll likely find the latest on this unfolding situation.

The latest bank to be caught up in the mess is First Republic Bank of California (FRC).

S&P and Fitch have downgraded First Republic to junk with negative outlooks, and Moody’s is also reviewing it for a downgrade. The new rating, BB+, is the highest level of junk implying a 14% chance of bankruptcy.

First Republic is slightly larger than Silicon Valley Bank (SVB) in terms of deposits, $176 billion vs. $172 billion, and would replace SVB as the second largest bank failure in history if it fails.

Management says it has $70 billion in liquidity available from JPMorgan and the Fed and has just 9% exposure to the technology sector (60% for SIVB).

However, the reason rating agencies have cut First Republic's credit rating is that it is primarily a rich person’s bank.

For example, Mark Zuckerberg has an account there. Since these are accounts larger than $250,000 in deposits, wealthy clients and companies might pull their deposits and send them to larger banks, such as Bank of America (BAC), JPMorgan (JPM), Wells Fargo (WFC), and Citi (C), the money center banks.

First Republic is now considering selling itself, which doesn’t instill confidence and could send depositors fleeing, possibly resulting in a failure in the coming days or weeks.

In the past week, BAC has reported $15 billion in new deposits. And the other megabanks have also seen strong inflows.

Thus, potentially around $60 billion in regional bank deposits have moved to megabanks. And if that continues for a full year, it’s about $3.2 trillion. That represents about 27% of all regional bank deposits.

For context, SVB’s collapse came after it lost $42 billion in deposits, or about 25%, in a single day.

The Fed’s new lending program provides unlimited funding equal to a bank’s risk-free bond portfolio (face value) for up to one year at 4.65%. This is designed to prevent deposit flight from forcing banks to sell bonds at a loss, which is what killed SVB and Signature.

With bond yields now crashing and bonds rallying at the fastest rate in 42 years, the paper losses banks face is lower. If 10-year US Treasury yields fall to 1.7%, the paper losses at banks will completely disappear.

That’s not to say regional banks aren’t still at risk. As deposits leave, regional banks will have to pull back on lending which will slow the economy.

Goldman Sachs (GS) estimates the likely tightening in credit conditions is the equivalent of another 25 or 50 basis points in Fed rate hikes. (And just yesterday, we saw a 25-basis point rate hike.)

The bond market expected the Fed to hike one more time, to 4.75% and then pause, before starting cutting rates 0.5% in July, possibly because of the upcoming debt ceiling showdown.

Moody’s estimates July 15 is the day when the U.S. will start to default on its debt—if the debt ceiling isn’t raised. The U.S. Treasury says it’s June 5, and the Congressional Budget Office estimates September 9.

By the end of the year, the bond market estimates the Fed will have cut 1% to 3.75% on its way to reaching its overall goal of 3.5% by May 2024.

This is because the bond market now expects a recession to begin around July to October 2023. If true, then the stock market historically would be expected to bottom at the end of the year.

Morgan Stanley (MS) thinks the S&P will bottom around 3,200 in September, coinciding with a potential debt ceiling showdown and peak earnings pessimism.

Historically, stocks reach new record highs around two years after the bear market low. That means the bond market is currently expecting U.S. stocks to reach new highs and the bear market to end around late 2025.

Meanwhile, things aren’t looking great across the Atlantic, either.

Back on March 15, Credit Suisse (CS) plunged as much as 30% when the Saudi National Bank, its largest shareholder, refused to invest more for regulatory reasons.

The bank has a three-year turnaround plan but expects to lose money for the next 12 months. And the stock price just hit a new record low, down 98% since 2007.

Credit Suisse has been in a never-ending 16-year turnaround and clients and deposits have been fleeing since 2021. In fact, its deposits fell from $436 billion in 2020 to just $254 billion at the end of 2022.

In 2021, they lost $1.7 billion and another $7.9 billion in 2022. In 2023, they expect to lose $2.4 billion.

The bond market is estimating a 38% chance Credit Suisse will go bankrupt in the next year, a 391% higher risk compared to March 15.

The Swiss National Bank has offered to lend to Credit Suisse to cover loans and short-term liquidity needs and the company says it might borrow up to $54 billion in the coming days. The bond market still thinks the company is at high risk of going under because customers and deposits continue to flee.

After facing two financial crises in the last 15 years, European stocks have been hammered, suffering two 3%-plus daily crashes just earlier this month.

The good news is that a failure of Credit Suisse is unlikely to trigger a European banking crisis. And the risk to the U.S. is even less.

Reuters reports, “Large U.S. banks have managed their exposure to Credit Suisse in recent months and view risks from the lender as contained so far, according to three industry sources on Wednesday who declined to be identified because of the sensitivity of the situation.”

Credit Suisse has been a basket case for years. And U.S. and European banks have been reducing their exposure to any potential failure steadily.

U.S. money center banks – the big banks that do the most business with Credit Suisse – have over $3 trillion in bonds that the Fed is willing to accept as collateral.

In other words, megabanks could borrow over $3 trillion from the Fed for 12 months at 4.65%, if the failure of Credit Suisse causes any financial issues.

With nearly $60 billion in new deposits flowing into megabanks just two weeks ago, there is virtually no chance big banks will fail due to Credit Suisse's issues.

In fact, here is what the bond market thinks are the risks of the megabanks defaulting on their bonds (going bankrupt) in the next year.

Rest assured that even if Credit Suisse fails, it will likely mean a few days of scary headlines and possibly a few bad days for the stock market. This is NOT a “Lehman moment” and the world’s financial system is not going to crash.

The bond market is about 99.5% confident Credit Suisse’s failure won’t result in a U.S. financial crisis.

But what if the bond market is wrong? How can we tell if the bond market’s estimates are reasonable?

Wide Moat Research uses several financial stress indicators provided by the St. Louis and Chicago Federal reserves that cover over 130 metrics updated weekly.

These indicators show financial stress is currently below average over the last 30 to 50 years.

They also factor in everything from yield curves to credit spreads, to delinquency rates on consumer and business loans.

If there was a financial crisis brewing, we’d see it the data. And right now, it indicates – despite all the fear and uncertainty in the markets and mainstream news – the U.S. financial system is in strong shape.

And if the facts change? Well, we’ll know about it and so will you, via our weekly video updates and monthly economic updates.

In today’s portfolio update, I’ll go over a sector update for our five financial stocks, Main Street Capital (MAIN), Toronto Dominion (TD), Manulife Financial (MFC), Legal & General Group (LGGNY), and Allianz (ALIZY).

Then I’ll give you three material updates from our positions this month. For a list of the most up-to-date investment advice on all our open position, visit our model portfolio page.

Fortress Financial Sector Update

From March 7 to March 15, our financial stocks in Fortress fell between 6% and 12%.

Many investors will naturally worry if this kind of rapid decline in a week means something is wrong with the companies. What is their exposure to the SVB and Signature Bank failures? What about the risk of Credit Suisse and a potential EU financial crisis?

For starters, no, Fortress Portfolio does not have any meaningful direct exposure to SVB and Signature Bank.

But I want to take some time to talk about where some of our financial positions stand today as a result.

Ratings agency Fitch reports that most exposure to the now-failed banks “appears to be confined to a limited number of bond funds, closed-end funds, and local government investment pools.”

Fitch points out that other major financial companies had just $1.2 billion in debt and equity exposure to the failed banks. This exposure was mostly from life insurance companies, but specialized ones, not like our holdings Manulife Financial (MFC) or Allianz (ALIZY).

Legal & General Group (LGGNY) is now a pure-play asset manager, having sold its insurance business to Allianz last year.

So our insurance companies are insulated from these two bank failures.

Next, what about concerns about spreading contagion in the financial sector? What about Credit Suisse?

Allianz is the largest insurance company in the world, and it does business with Credit Suisse. However, this isn’t likely a big risk to Allianz’s business or dividend safety, and here’s why.

What about real-time risk changes at Allianz? The news is changing by the day, and here’s how we can have confidence that our companies are safe even as the fast and furious headlines fly at us.

Credit default swaps or CDS are publicly traded insurance policies that bond investors take out against potential bond defaults. Since bond investors are the most conservative on earth (considered the “smart money” on Wall Street), and are concerned primarily with preserving their capital, CDS allows us to monitor a company’s fundamental risk in real-time.

We have access to CDS data that allows us to track in real-time what bond investors think about the fundamental risk and financial health of every company we own as news breaks.

For example, here’s what the bond market thinks about Allianz’s risks of defaulting on their bonds (going bankrupt) in the next 12 months: 0.2357% probability. That is…

We also see how its 2, 3, 5, 7, and 10-year fundamental risks change over time.

While Allianz’s risks are up significantly since the crisis began, they remain very low in absolute terms. The bond market is pricing in a 2.1% chance that Allianz will go bankrupt in the next 30 years, the equivalent of an A-rated company.

So even with financial uncertainty soaring in the last week, the bond market agrees with rating agencies: There is no major reason to fear that Allianz will be hit by anything that’s going on with Credit Suisse.

Legal & General’s credit default swaps are rock steady over the last day, week, and month, as well, pricing in 0.3% fundamental risk in the next year.

The same is true for Manulife Financial, which is another A-rated insurance company.

Moving to our bank-related companies…

According to all rating agencies, Toronto Dominion (TD) is the 20th safest bank on earth, with an AA-credit rating and $7 billion in cash on hand. It also has access to hundreds of billions more within a day or two courtesy of the Federal Reserve.

And Main Street Capital (MAIN) didn’t bank with the failed companies and had no direct business with Credit Suisse, though its portfolio of 300 loans to private businesses might face some stress in a recession.

I have every stock in the Fortress Portfolio (and Wide Moat Master List of 500 companies) tracked by FactSet and Google News. There isn’t a single company headline I don’t see throughout the day as news breaks.

And Google News sends me analyst reports about individual companies, specifically those with major downgrades or upgrades about company fundamentals.

If anything important changes in the coming weeks or months or during the recession, I’ll adjust our safety and quality ratings and let you know.

Toronto-Dominion (TD): $1.2 Billion Settlement Over Ponzi Scheme Lawsuit

In 2012, disgraced financier Allen Stanford’s $7 billion Ponzi scheme involving certificates of deposits collapsed. He was sentenced to 110 years in prison.

And Toronto Dominion has been sued over its involvement in moving the money.

Toronto Dominion wasn’t involved in the fraud; it was just processing payments. This is like Mastercard or PayPal being sued for processing payments for someone who turns out to be a criminal.

The settlement is after 10 years in court, and Toronto Dominion is simply trying to put this headache behind it.

Two other banks also settled their own lawsuits in this case, including HSBC, one of the world’s largest banks.

How worried should dividend investors be at the $1.2 billion cost? This is an AA-rated bank, and rating agencies consider it the 20th safest bank on earth (the 10th safest that’s publicly traded).

Toronto Dominion ended the year with $7 billion in short-term liquidity, which will barely dent its balance sheet and won’t put the dividend at risk.

After the news came out, analysts upgraded Toronto Dominion's long-term growth outlook from 8.7% to 9%, the upper end of management guidance. The settlement probably has nothing to do with it, but the point is that Toronto Dominion is not a Ponzi organization and is one of the world’s most dependable and trustworthy companies.

S&P considers its long-term risk management, which includes managing reputational risk, in the top 4% of all global companies.

Put another way, Toronto Dominion's long-term risk management over issues such as this is in the top 320 companies on earth.

TC Energy (TRP): Coastal GasLink Cost Overruns and Keystone Spill

Back in December, TC Energy suffered a 13,000-barrel oil spill on its Keystone pipeline in Kansas.

The company hasn’t put out estimates for the total cost, but analysts estimate about $475 million is close to the final bill.

TC Energy's insurance will cover this, so the company's final out-of-pocket expense is likely to be regulatory fines from the Environmental Protection Agency (EPA).

This kind of industrial accident is part of the industry’s risk profile because spills like this can cost around $1 billion to clean up.

S&P downgraded TC Energy's credit rating of BBB+ (stable) to a negative outlook in recent weeks. Moody’s and Fitch also downgraded their A- (stable) rating to a negative outlook.

A negative outlook means a 33% chance of a downgrade within two years.

But this has nothing to do with the spill and is due to TC Energy reporting that its Coastal GasLink project, the largest in its backlog, is going to cost $2.4 billion more than previously expected.

Per S&P, “Based on our base-case assumption, we forecast debt-to-EBITDA (cash flow) of about 5.4x in 2023 and 5x in 2024."

Rating agencies consider 5X or less net debt/cashflow safe for a midstream company. And TRP's leverage might exceed that slightly this year due to its $10.7 billion in growth spending in 2023. Here is the FactSet consensus for absolute leverage.

Management says it has a plan to bring its debt/cash flow ratio down to 4.7X by 2026 while paying dividends that grow 3% to 5% each year.

We remain confident that TC Energy's dividend will remain intact. Here’s why:

We’ll continue to monitor the situation and let you know if anything changes.

Pimco Managed Futures (PQTAX): Why It Fell 6% Right After the SVB Crisis

Managed futures are part of our hedging strategy. And since 1980 there hasn’t been a bear market in which a strategy of managed futures + bonds didn’t stay flat or go up while stocks fell.

That’s also true in this mini banking crisis:

Pimco Managed Futures (PQTAX) is down 6.3%, but the PIMCO 25+ Year Zero Coupon US Treasury Index ETF (ZROZ) is up 4.5% for a total return of -1% for the 33% hedging bucket during the crisis. 

Why is Pimco Managed Futures suffering so much? Actually, it’s holding better than most of its peers. Here are the returns for the most popular managed futures funds since the start of the crisis on March 9th.

What’s going on with managed futures? Why is the best asset class of 2022 now suffering so much? To understand that, we have to remember what managed futures do.

These are mostly trend-following strategies that use options to go long or short on stocks, bonds, commodities, and currencies.

In 2022, we had a prolonged trend of falling bonds due to soaring interest rates and a strong dollar, which meant they shorted most other currencies.

They were long commodities at the start of 2022 (because of high inflation). And when Russia invaded Ukraine and sent commodity prices soaring, they benefited immensely.

They were also mostly short on U.S. and foreign stocks that had a terrible 2022.

So what changed in 2023?

Starting in October, foreign stocks – specifically in Europe and European financials – took off like a rocket. In fact, before the crisis, EU banks were up 60% from October to early March, and the London Stock Exchange was at all-time highs (due to financials and energy).

When trends change so drastically, trend followers adapt. And at the start of the crisis, here is the basic portfolio they all held:

Since the start of the crisis, we’ve seen the strongest bond rally in 41 years, including a historic rally in 2-year U.S. Treasurys.

On Wednesday, March 8, Fed chairman Jerome Powell told the Senate that interest rates would have to go higher than previously expected and the bond market was pricing in at least 1% more hikes by mid-year.

(And he delivered. On March 22, the Fed again raised rates by 25 basis points.)

The day after Powell’s announcement on March 8, SVB imploded, and the bond market changed its mind in a hurry. Bond yields crashed, bonds soared at the fastest rate in decades, and the entire managed futures industry was caught in almost all the wrong positions.

The U.S. dollar has soared due to a flight to safety.

Bonds are rocketing higher due to recession fears and expectations the Fed will cut 1% by year-end.

Cyclical commodities have plunged due to recession worries.

EU stocks, heavily exposed to financials, have been falling by 3% per day.

The good news is that managed futures adapt over time. In the last two weeks, they trimmed their short bets against bonds by 50%. We know because these funds provide their exact portfolio positioning daily.

However, they generally use two-month time frames with daily, weekly, or monthly rebalancing, to manage their options portfolios.

In other words, if the world changes overnight, trend-following managed futures can be caught flatfooted for several weeks.

For example, during the Pandemic crash – in which stocks fell 34% in a month and then rocketed 70% from those highs in the following year – managed futures were flat.

This time, we went from the strongest rising rate regime in 42 years to a plunging rate regime overnight. And managed futures’ long EU stock positioning is proving to be a major headwind.

But it’s important to remember: We’re not market timers at Fortress.

Managed futures, like bonds and stocks, are an asset class you should always own.

The industry’s largest decline since 2000 is 26%, from 2016 to 2019. During that time, stocks were up 72%, and a 67% stock/33% managed future portfolio was up 42%, or 9% annually.

The only year since 1988 when managed futures and stocks both fell in the same year was 2002.

In other words, had you been 67% stocks/17% managed futures/17% long bonds in 2002 (like our asset allocation model at Fortress Portfolio recommends), the last year of the tech crash, your portfolio would have been just fine.

We built Fortress Portfolio to average 50% smaller declines during even the most extreme market crashes.

In any given day, week, or month, any asset you own can swing wildly. The goal of Fortress is to use optimal asset allocation, which determines 90% of long-term investing returns.

No strategy is going to work all the time. If it did, everyone would buy only that strategy, and it would stop working.

The point of our blue-chip stocks is to provide maximum safe income and strong returns.

The managed futures are there for “crisis alpha” such as 2022, 2008, and the tech crash – all periods when managed futures soared.

Bonds are in the portfolio for the black swan events like 9/11, the Pandemic crash, SVB’s collapse, or hypothetically war.

For example, long bonds were up 16% during the Pandemic crash, when managed futures were flat.

So the hedging portfolio would have been up 8.5% when the market was down 34%. A 67% stock/17% managed futures/17% long bond portfolio would have been up down 20%, that’s 42% less than the market.

Managed futures + bonds were 84% effective even in this freak market crash.

In other words, even though the Pandemic was a black swan event that struck without warning and the stock market crash ended almost as soon as it began, this hedging strategy was still 84% effective.

By the time the recession strikes in late 2023, managed futures will likely be perfectly positioned to combine with long bonds to provide spectacular hedging.

In most recessions, they go short commodities, short stocks, long bonds, and long the dollar.

When black swans strike, managed futures and bonds tend to be flat. And if the crisis persists then managed futures pivot to become optimally positioned for bear markets.

And in inflationary times like the 1970s? Managed futures are the best-performing asset you can own, with 22% annual returns during the stagflation hell of the 1970s.

So we’ll continue holding them as inflation stays high in our Fortress Portfolio as part of our overall hedging strategy.

Source: Gurufocus Premium

I welcome your questions and will try to answer as many as I can in the weekly update videos and these monthly newsletters.

We didn’t get many new questions this month, so please send in any concerns or comments.

Just remember I can’t give individual investment advice. But I can provide information about the broader economy, companies, as well as reasonable and prudent investment advice for the average investor. Write in with your questions here.

Safe investing,

Adam Galas Chief Analyst, Fortress Portfolio