NEW YORK (Reuters) - It’s the newest market riddle: where do you go for safety when the traditional option could be in a bubble?
With fiscal problems in Europe once again leading to sharp drops in global stock markets, many investors are seeking out stable assets that can both protect their principal and generate an income stream to keep up with inflation. Yet the most obvious choice - U.S. Treasury bonds - offer historically low yields. The benchmark 10-year Treasury yields 1.90 before taxes, well below the 2.26 percent annual rate of so-called “core” inflation, according to the U.S. Consumer Price index.
“We regard Treasuries as something close to a bubble where people could lose an incredible amount of money,” said Ron Weiner, president of RDM Financial Group in Westport, Connecticut.
Rather than dig deeper into U.S. government debt, financial advisers and money managers are expanding the scope of their fixed-income holdings. They are taking a look at non-traditional assets like seaports, master limited partnerships and preferred stocks.
Here are suggestions on strategies to increase yield while maintaining a conservative portfolio.
Kate Warne, investment strategist at Edward Jones, said that Treasuries “aren’t the safe haven they once were” and suggested investors move to diversify their portfolios to include additional corporate and municipal debt. Some corporate and municipal bonds may offer the same reliability as Treasuries but pay much better rates, analysts say.
Weiner, from RDM Financial Group, has been moving assets out of Treasuries and into corporate and emerging market bonds. In particular, he’s targeting corporate bonds that are rated between AA and BB, a range that mostly includes so-called “investment grade” ratings, creating laddered portfolios that pay an average yield of 4.5 percent and have an average maturity of 6 years. Last August, Standard & Poors downgraded U.S. Treasuries to AA plus, the second-highest rating.
“These are companies that are awfully strong financially and are not going out of business in an average of six years. You may not want to own their stocks, but their bonds will do very well,” he said.
His holdings include companies like Peabody Energy and Constellation Brands, both rated BB-plus, the highest junk rating, according to Thomson Reuters data. He also has Pitney Bowes, whose issues have a BBB-plus rating by S&P, or three levels above junk.
Robert Tipp, chief investment strategist for Prudential Fixed Income, said the yield of the 10-year U.S. Treasury will likely remain below 4 percent for years.
“While the supply of credit is low, the demand remains very strong, and I don’t see that changing for a while. As a result, I think the best opportunities are not in Treasuries,” he said.
Tipp said that the best opportunities for investors will likely be investment-grade financial bonds and long-term medium-grade municipal bonds. These issues are likely to do well if the economy continues to grow at a modest pace, he said.
“It’s not a very strong economic environment out there, but it’s not a terrible one either,” Tipp said.
The Pimco Intermediate Municipal Bond Strategy ETF is one option for investors who opt for a fund approach for their fixed income exposure instead of holding individual issues. The $149 million ETF charges 35 cents per $100 invested and is up 2 percent since the start of the year. About 33 percent of its assets are in education bonds, followed by 13 percent in state and local general obligation bonds and 11 percent in health bonds, according to Morningstar.
Moving outside of the fixed income market may offer higher yields with comparable reliability, some analysts contend.
Jim Sloan, a financial adviser in Houston, Texas, said that he is moving more of his clients into liquid assets that they may be unfamiliar with like master limited partnerships and preferred stocks, a share class that functions as a hybrid between as a stock and a bond.
“Most people just get caught up in stocks and bonds. That’s just two asset classes. You need to look elsewhere,” he said.
Preferred shares, for instance, offer investors greater protection in the event of a company bankruptcy than common shares, which are often wiped out. Generally, the dividends for preferred shares are fixed, and must be paid out before any dividends to common shareholders.
The $8.6 billion iShares S&P U.S. Preferred Stock Index is one popular option for fund investors. The ETF charges 48 cents per $100 invested and has a 12-month yield of 6 percent, according to Morningstar. Preferreds issued by financial companies dominate the fund, which could limit price appreciation over the next year.
Sloan is also moving more client assets into the stocks of global infrastructure companies that run things like seaports and toll roads.
“These aren’t real sexy, but this is a conservative way to get yield,” he said, mentioning the company’s reliable income streams and history of large payouts to shareholders.
The iShares S&P Global Infrastructure Index ETF is one inexpensive way to get exposure to the sector. The fund, which costs 48 cents per $100 invested, yields 4.1 percent and is up 7 percent since the start of the year, according to Morningstar. Its top holdings are Transurban Group, Enbridge Inc, and TransCanada Corp.
Reporting By David Randall; Editing by Walden Siew and Andrew Hay