Published: July 20, 2010

What a roller coaster. On Friday the markets drop about -3%. I know investors are wondering what they should do.

In most cases, I think the answer is "nothing." As Warren Buffett said, "I buy on the assumption that they could close the market the next day and not reopen it for five years."

That being said, I know it is hard to sit still while the market swings back and forth, so I wanted to offer an idea that could help you sleep better tonight. I actually added this to the Government-Driven Investing Portfolio in late May and have seen a nice return (and minimal volatility) since then.

This company is a beneficiary of not only government action but also of government strength, and this combination means it is very resilient during market turbulence.

The company is called Capstead Mortgage (NYSE: CMO), and it's organized as a real estate investment trust (REIT).

A little background:

Even though I don't think we're headed back into the financial abyss, I know we all can remember what it was like when the economy looked as if it were going to collapse under the weight of the subprime debacle. One of the things the government did to make sure that the housing market didn't crater even more was to step in and guarantee certain mortgages. If the borrower defaulted, Uncle Sam would step in, like a co-signer, and make good on the loan.

The risk of mortgages is two-fold: Prepayment and default. Prepayment risk means that a borrower will pay back what they owe sooner than anticipated. This is a "risk" because it is uncertain whether another lending opportunity -- and substantially equivalent income stream -- will be available.

The second risk, of course, is default, which occurs when borrowers fail to make their monthly payments. While prepayment risk is unavoidable, it's nowhere near as worrisome as default risk. Prepayment means you miss the opportunity to make money, default almost always means a loss. So by shouldering this downside, the federal government helped shore up the housing market by ensuring that borrowers could get loans.

 

Though these loans may yield between 4-6%, this government-backed mortgage debt is no more risky than a Treasury bill. It is these mortgages that are the bulk of Capstead's holdings.

The really elegant part of this company is that it is leveraged. It not only uses investors' capital to buy mortgages, it also uses borrowed money.

As you know, interest rates are very low, and short-term rates are almost nothing. So Capstead borrows for the short term at low cost -- rolling loans among a handful of big banks -- while lending money for the long term at a higher rate. Capstead keeps the spread for its troubles, and pays out 95% of its net earnings to shareholders.

So not only is Capstead a safe place to park your money, it also pays a nice return. In fact, its current payout of $0.36 per quarter implies an astonishing 12.0% yield, far better than the overall market. Its five-year total return, on an annualized basis, is +16.4%. The S&P 500, for that period, is -0.8% per year.

Capstead also offers a very low "beta," a market measure that compares a security's volatility to its benchmark. A beta of 1.0 means the security correlates exactly to the movement of the index. Capstead's beta is 0.62, which means it is far less reactive to the market's swings. This and its strong yield make the company a nice place to take advantage of government action and safely park some cash during tumultuous times.

Action to Take --> I've already added shares of Capstead Mortgage to my Government-Driven Investing Portfolio, and I'm currently sitting on a nice gain while being able to sleep at night.

I know things seem a little tenuous. Rest assured that things will improve, and consider Capstead if you're looking to make a defensive move to protect your portfolio from the market's jitters.

-- Andy Obermueller
Chief Investment Strategist
Government-Driven Investing, Fast-Track Millionaire