Looking at the U.S. Treasuries market, fixed-income investors are faced with lackluster returns as the Federal Reserve's unprecedented loose monetary policies continue to suppress yields. However, investors can turn to alternative sources, like the buy-write strategy and senior loans in an exchange traded fund form, to bolster an investment portfolio's current income.
Treasury yields are hovering below 2 percent and it won't change anytime soon as the Federal Reserve is committed to keeping yields artificially down. Specifically, the Fed will maintain the near-zero interest rates until 2015, engage in the new quantitative easing plan to buy mortgage-backed securities and continue with "Operation Twist."
In response, investors have already turned to alternative sources for yields. For instance, corporate debt has garnered a larger following this year, specifically in high-yield or "junk" bonds. Nevertheless, most investors are honing in on the usual fixed-income suspects. Instead, fixed-income investors can look at the buy-write, or "covered call," strategy and senior loans as new sources for yield.
What To Know About Buy-Write ETFs
The buy-write, or covered call, strategy utilizes call options on a position to generate added income from option premiums. Trading a buy-write strategy, an investor would sell a call option above the current price of a security. If the price of the security is below the option upon the expiration date, the investor would pocket the difference.
Buy-write traders would only lose out on the difference of the exercise price and the market price. During market turns, traders can lose money if the security drops by more than the amount of the premium received -- the premium acts like a buffer in case of significant market dips.
The buy-write strategies "provide option premium income that can help cushion downside moves in an equity portfolio, but buy-writes often underperform stocks in rising markets," according to the CBOE. "Buy-write strategies have an added attraction to some investors in that buy-writes can help lessen the overall volatility in many portfolios."
The PowerShares S&P 500 BuyWrite Portfolio (PBP) is the largest of the buy-write funds, with $279.3 million in assets. The ETF tries to track the CBOE S&P 500 BuyWrite Index, which measures the total rate of return of the S&P 500 covered call strategy. PBP comes with a 0.75 percent expense ratio and offers a 10.4 percent yield. The S&P 500 is up over 14 percent year-to-date while PBP is only up 7 percent year-to-date. Nevertheless, the buy-write ETF has experienced much less volatility and offers a robust yield.
The ETF's sector allocations include consumer discretionary, 11.1 percent; consumer staples, 10.9 percent; energy, 11.2 percent; financials, 15.1 percent; health care, 12.2 percent; index futures, -0.4 percent; industrials, 9.9 percent; information technology, 19.4 percent; materials, 3.5 percent; telecom services, 3.2 percent; and utilities, 3.7 percent.
In September, AdvisorShares launched the actively managed AdvisorShares STAR Global Buy-Write ETF (VEGA), which actively applies the buy-write strategy to a global exposure. As of September 30, the managers have allocated 13 percent to domestic energy sector, 15 percent to domestic equities, 12 percent to domestic real estate, 15 percent to emerging market equities, 1 percent to options and 45 percent in cash equivalents. VEGA comes with a 2.01 percent expense ratio.
Additionally, iPath CBOE S&P 500 BuyWrite Index ETN (BWV) is an exchange-traded note that follows the CBOE S&P 500 BuyWrite Index. As an ETN, BWV is essentially an uncollateralized loan to an investment bank and leaves investors open to potential credit risks of the issuing bank -- if the bank goes under, there is no guarantee that the ETN investor will receive all of his or her principle back. While the ETN tracks the same benchmark as PBP, ETN has only gained 5.59 percent year-to-date. BWV has a 0.75 percent expense ratio.
The High-Yield Senior Loan ETF
Bank loans have taken a back seat for the past year, but as investors search to squeeze income out of the market, senior loans have attracted a wider audience.
The PowerShares Senior Loan Portfolio (BKLN) provides exposure to the S&P/LSTA U.S. Leveraged Loan 100 Index, which tracks the largest institutional leveraged loans based on market weighting, spreads and interest payments. BKLN has a 0.76 percent expense ratio and a 4.40 percent 30-day SEC yield.
Senior bank loans are private debt instruments issued by a bank and provide capital to companies that typically fall below investment-grade credit ratings. Consequently, many investors have associated senior bank loans with speculative grade, or "junk," bonds. However, while both junk bond and senior loans may be rated below investment grade, senior bank loans come with a little less risk since these notes are secured by collateral in the event of bankruptcy.
If a company goes under, the loan is considered senior to all other claims against the borrower, so senior bank loans are first to be repaid, ahead of other interested parties, such as creditors, preferred stockholders or common stockholders.
Moreover, when interest rates do begin to rise, investors in bank loans are in a better position than a bond investor since bank loans are based on floating rates. Although rates are not scheduled to rise anytime soon, when they do, bank loan investors won't have to sell as senior bank loans will be able to shift with interest-rate changes over the long-term.
For those seeking to augment their investment portfolio's current income, buy-write and senior loan ETFs provide an interesting alternative to the traditional fixed-income options.