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2013-12-31 TIA PIP Annual Letter

December 31, 2013

Dear Mr. and Mrs. Jack Smith,

This is our 2013 annual client letter for our Preferred Income Portfolio (PIP).  We have completed our fifth full year with this fixed income portfolio.  In the fourth quarter of 2008, TIA introduced this portfolio as a fixed income alternative to common stocks.  Preferreds were selling at deep discounts to their $25 par value with double-digit yields.  Our preferreds were competitive with a very strong stock market in 2009 and 2010. 

After the “Credit Crisis” the financial industry recovered faster than the general economy due to Federal Reserve policies and governmental support.  PIP experienced no bankruptcies or omitted dividends during the worst recession since the great depression.  We consider credit risk to be the major investment risk but we have diversified the portfolio with 30 issues and financially strong companies.  It is important to remember that the word “Preferred” indicates the securities have preference over the common stock.  Most economists do not expect another such financial event in our life time.  After this strong financial performance our current yield spread (greater yield) over the historical benchmark US 30-year Treasury settled in at +4.0% compared to its +1.5% to +2.0% historical spread.  In 2006 preferreds and the benchmark 30-year had the same 6.0% yield (no spread) leading up to the “Credit Crisis”.

Since 2011, our PIP has been utilized strictly as an income strategy for fixed income clients.  However, we do believe our PIP could be competitive with equity returns over the next four years.  Several leading pundits (including Warren Buffett) are on record with forecasted future equity annual returns in the range of +6.5% to +7.5%.  The investment performance of our PIP in 2013 was disappointing due to its +7.0% income return being offset with a 10% decline in market value for a negative -3.0% total return.  It is important to remember; however, that the investment objective is the 7.0% yield and the market price is only a factor if issues are sold.  Real Estate Investment Trusts (REITS) declined in 2013 after having tripled in price from their lows in 2009.  Investors took profits and expressed concerns with the Federal Reserve taper talk.  The primary reason for the PIP price decline was due to these REIT preferreds, which declined in sympathy with their underlying common stocks.  In January, our PIP rallied +3.0% due to this sector plus a mild decline in interest rates.  REIT preferreds, comprised of several industries owning land and fixed assets, represent 50% of the PIP because they offer diversification which is not available in most financial companies

TIA has a call requirement on our PIP to protect our clients from the “perpetual ownership trap” (no maturity).  Preferreds are issued in perpetuity, but with five years of call protection.  Traditional preferreds with a dividend (coupon rate) greater than 6.5% have been called on schedule (only two exceptions since January 2001).  We have a policy of only purchasing issues with a coupon rate over 6.5% yield (one exception out of 30 issues).  Our PIP has an average coupon of 7.21% with 46 months of call protection.  Our other two yield requirements are a minimum of 6.0% current yield and minimum yield-to-call equal to the US 30-year yield.

We are enclosing a Wall Street Journal article from October 10, 2013 (please review).  The article discusses the preferred sector with several favorable observations.

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