CHICAGO (Reuters) - If you’re willing to take on more risk, it’s a good time to move beyond corporate and government bonds in the incredibly challenging search for yield.
While attention has been on the record-setting stock market - the Dow Jones Industrial Average closed above the symbolic 15,000 on Tuesday and kept climbing - bond yields have been heading south. The benchmark 10-year U.S. Treasury is yielding around 1.8 percent after hitting 2 percent in early March.
An “in-between” portfolio that focuses on yield from non-traditional sources while owning dividend-rich stocks is one approach to find income. This strategy is based on the reality that bond yields probably won’t rise much in the next year or so. You’ll have to venture into alternative investments if you want to boost your income stream.
I’ve searched for some of the best exchange-traded funds (ETFs) that offer income and appreciation. The following ETFs focus on four key themes: Global stock dividends, master limited partnerships (MLPs), high-yield bonds and real-estate investment trusts (REITs).
Dividend-paying stocks, for example, can outpace inflation. In January 2009, the S&P 500 Index dividend yield was 3.24 percent while the Consumer Price Index was a negative 0.34 percent, according to dividend.com.
That doesn’t always happen. Even so, cash-rich companies are in a better position to raise dividends - something bond payers can’t do.
This mix is not risk-free. It may get hit as hard in a stock market sell-off, which is why these funds should comprise no more than 15 percent of your total holdings.
The PowerShares International Dividend Achievers ETF gives you a selection of dividend payers from around the world. If something happens to the torrid U.S. market, you have a little insulation.
The fund, which yields just above two percent, holds brand-name non-U.S. stocks like Vodaphone and Nippon Telegraph and Telephone.
It’s posted an annualized return of nearly 14-percent during the three years through May 8, and is up 20 percent for the past year through that date. The trade-off, however, is that the fund is more volatile than the S&P 500.
REITs that invest in mortgages have done well since 2008, thanks to low financing rates, although they are not well known. The iShares FTSE NAREIT Mortgage PlusCapped Index invests in major REITs like Annaly Capital Management, which buys mortgage pass-through certificates and obligations.
This specialized REIT borrows money to buy mortgage-backed securities. Like all REITs, it must pass through 90 percent of its income to shareholders.
Currently, the iShares fund is yielding 11 percent. The downside is that it trades like a stock, and its risk is roughly the same as the S&P 500. It’s up 24 percent through May 8, and has averaged an annualized gain of 15 percent during the past three years.
Until recently, you could only buy these vehicles through brokers, often paying steep commissions. Now that they’re being packaged in ETFs, they are worth considering for their high yields, which range from 7 percent to 16 percent.
The Alerian MLP ETF, up 15 percent in the past year through May 8, holds an index of energy partnerships that mostly invested in pipeline companies. With an almost 6-percent yield, the fund probably won’t move in lockstep with common stocks, but it’s prone to declines if oil prices slide. The ETF is less than two years old, so it’s too young to have risk measures.
Unlike their government counterparts, “junk” bonds give you the trade-off of lower credit ratings in exchange for higher yields. Rated “B” and lower, these are companies that still need to sell debt, but pose a higher risk of default.
Packaged within an ETF such as the Peritus High-Yield ETF, you can find some diversification from credit risk. Although it is actively managed and has a much higher expense ratio than its peers - 1.35 percent annually versus 0.4 percent for a similar indexed fund - the Peritus fund sports an 8 percent yield.
It is up 13 percent for the year, besting its benchmark by 2 percentage points, which is a significant advantage in the bond world.
As a backstop, keep a close eye on interest rates with all of your bond holdings.
“Be tactical so that you can be ready for the eventual rising interest-rate environment,” advises John Zhong, chief executive officer and founder of MyPlanIQ.com, a portfolio service.
(The author is a Reuters columnist. The opinions expressed are his own.)
Editing by Lauren Young and Bernadette Baum