COLUMN-Three ways to enhance yield in a QE3 environment
By John Wasik
CHICAGO, Sept 21 (Reuters) - In what may be a last-ditch effort to resuscitate employment and economic growth, the Fed has embarked on a third round - QE3 - of buying Treasury and mortgage bonds to lower long-term interest rates and provide an incentive for companies to hire and banks to lend.
The Fed said last week it will be buying $40 billion worth of debt securities every month until the labor market rebounds significantly.
Whether the Fed's program will work remains to be seen - the jobless rate has been stuck around 8 percent despite two previous easings - but it needn't be another body blow for income-oriented investors who will suffer because of painfully low savings yields, which may even drop slightly.
If you can afford to take on more risk, you can find higher-yielding investments to enhance your portfolio. It will involve a departure from principal-guaranteed vehicles but may provide a higher income stream if the economy continues its recovery.
An improving economy - Fed-induced or not - makes some of the more volatile yield-enhanced vehicles somewhat less risky. Junk bonds from companies with less-than-stellar balance sheets will have a lower tendency to default.
A yield-enhancement strategy can supplement your "safe" money with higher-returning funds. Of course, as with any new approach that delivers more return, you have to keep an eye on risk. And how much of a yield-enhancement strategy you adopt depends on your cash-flow needs. If you need an absolutely safe reserve for daily living, taxes, emergency, medical or college expenses, then take a big sigh and stick to federally insured products. Here are three main areas to consider:
1. Real Estate Investment Trusts (REITs)
These publicly traded companies own mostly commercial real estate and mortgages. You can get ultra-specialized or own a broad portfolio of properties. In the first half of the year, REITs outperformed the general stock market on total return and yield, according to NAREIT, the trade organization representing REITs.
The FTSE NAREIT All-Equity Index was up nearly 15 percent for the year through June 30. Yields on REITs, which pay out the lion's share of their earnings to investors, are typically higher than those of common stocks. The FTSE NAREIT All-REIT Index yielded 4.2 percent in the first half. An improving economy would create even better fundamentals for REITS.
In a post-QE3 environment, you could do even better with REITs that only hold mortgages, with a 13 percent yield for the NAREIT mortgage index. An exchange-traded fund that holds a basket of mortgage REITs is the iShares FTSE NAREIT Mortgage Plus Capped Index fund, which had a recent annual yield of more than 11 percent.
For international exposure, consider the Vanguard Global ex-U.S. Real Estate ETF, with a 2.7-percent yield. Keep in mind that REITs do best in an environment of rising rents and property values. If the tide turns, they can lose money.
2. High-Yield Bonds
As with REITs, high-yield bonds also can be worthwhile additions in an improving economic climate. These securities are issued by companies that are not in tip-top financial shape, so they offer higher-yields to attract investors.
They are best purchased in ETF portfolios such as the SPDR Barclays Capital High Yield Bond ETF, yielding 7 percent, or the PowerShares Fundamental High Yield Corporate Bond ETF, yielding 5 percent. Like all junk bond portfolios, these portfolios hold the lowest-rated corporate bonds, so they are highly sensitive to economic conditions. They are best-suited to holding during economic upswings.
3. Emerging-Market Bonds
If you look outside the U.S. and euro zone, you can often find better-yielding government bonds, which look even better as yields fall on U.S. Treasury bonds.
Developing countries often have high credit ratings and attractive yields. The SPDR Barclays Capital Emerging Markets Local Bond ETF offers a portfolio of investment-grade debt from developing countries. Its total return was 8.3 percent through Sept. 19.
There's a double-edged sword to these kinds of funds, though. In addition to all of the other bond-related risks, you also have currency fluctuations since the bonds are not denominated in dollars. That could work in your favor if the dollar drops against those currencies, which is often the case during a Fed easing. Part of an enhanced total return can be non-dollar-denominated currency gains.
Always look at bond ratings within a portfolio. The lower the letter grade, the higher the risk. Duration, or the amount of money you'll lose if interest rates rise one percentage point, is another key bond-risk gauge.
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