Many older clients come to financial advisors with a clear and simple mandate: devise an investment plan to help fund a comfortable retirement. At a minimum, their retirement income streams must jibe with their projected expenses. Much of that income may come from pension income, Social Security benefits, annuities or investment account drawdowns.
Income-producing investments can play another role in filling out the plan. Trouble is, the Federal Reserve Board’s recent decision to (likely) refrain from further rate hikes means that income streams from plain-vanilla fixed-income investments are subpar. To remedy that, advisors need to help their clients stretch for yield.
And certain exchange-traded funds produce more higher payouts than many realize.
Know The Trade-Offs
Of course, to glean strong fixed-income yields your clients will need to shoulder some risk. Long-term government bond funds, such as those in the iShares 20+ Year Treasury Bond ETF (TLT), have 30-day SEC yields below three percent.
Investment-grade bond funds do a little better. The iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD), for example, sports a higher 3.7 percent yield. Both iShares funds carry 0.15 percent expense ratios.
Taking on greater risk can help you move up the income curve. The Vanguard Long-Term Corporate Bond ETF (VCLT) carries a decent 4.37 percent 30-day SEC yield, and a rock-bottom 0.07 percent expense ratio. Fully 54 percent of the fund is invested in bonds that are rated Baa or lower. (Baa is the low end of the high-grade market, while anything lower, such as BBB, is where the high-yield (i.e. “junk bond”) market begins.
Looking for even greater exposure to high yields? With more than $17 billion in assets and a 0.49 percent expense ratio, the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) is the category’s largest. The 30-day SEC yield of 5.36 percent is more than two percentage points greater than you’ll capture form a high-grade bond fund.
The SPDR Bloomberg Barclays High Yield Bond ETF (JNK) may be a slightly better choice. Not only does it have a lower 0.40 percent expense ratio, but it also offers a more robust 5.73 percent 30-day SEC yield. The key difference is that the SPDR fund owns a higher percentage of B-rated or lower bonds.
I’m a big fan of the “fallen angel” approach. This strategy focuses on bonds that were once investment grade but were more recently subject to ratings downgrades by the major bond ratings agencies.
Bond traders tend to unload such bonds as underlying fundamentals deteriorate—in advance of an actual downgrade. They know that an eventual downgrade could be imminent, which often triggers a sell-off from funds that can’t hold sub-investment grade bonds.
The VanEck Vectors Fallen Angel High Yield Bond ETF (ANGL) aims to profit from these U.S.-denominated bonds while they are out of favor. According to VanEck, fallen angel issuers tend to be larger and more well-established companies, and fallen angels have outperformed the broad high-yield bond market in 11 of the past 15 calendar years. The fund tracks an index that focuses on the highest-quality bonds in the group. ANGL has a 0.35 percent expense ratio and a 5.89 percent 30-day SEC yield.
The real differentiator with this fund is its potential to profit from a price rebound in these bonds as they regain their investment-grade status. The ANGL ETF has delivered a 38.6 percent total return over the past five years, according to XTF Research. That blows past the 19.8 percent total return for the HYG fund and the 22.1 percent return for the JNK fund.
Despite the allure of higher-yielding fixed-income ETFs, Sound Asset Management’s Russell Wayne reminds clients that they can lose value in tougher market conditions, and their prices can fall in any given year. “If your client can’t stomach that risk, then they may as well stick with CDs [certificates of deposit],” says Wayne.