Who doesn’t love investment income? Perhaps the better question is: Where are the best sources to find income in the current market environment?
The decade-long funk in bond yields in the aftermath of the financial crisis has forced many income-hungry investors to jump into dividend-paying stocks, helping to push up valuations and causing people to wonder how much longer the good times can last. At the same time, the confluence of ongoing interest rate hikes by the Federal Reserve, coupled with the pending impact of the recent federal tax overhaul plan, adds new dynamics to stocks and bonds and the yields they pay.
During a panel on Monday at the Inside ETFs conference in Hollywood, Fla., several ETF industry folks gave their three cents on where investors can turn to for alternative income sources beyond traditional dividend-paying stocks and bonds.
Senior Bank Loans
“We think the senior bank loan area is worth a serious look,” said Christian Magoon, founder and CEO at Amplify ETFs.
Senior bank loans are typically made to companies rated below investment grade, so they tend to have higher yields to compensate for the risk. But they’re generally safer than junk bonds because senior loans are secured by collateral and are at the top of a company’s capital structure, so investors in senior loans get paid before other holders of debt obligations against the borrower. These loans can be volatile, though.
Magoon noted the duration, or interest rate risk exposure with senior loans is "quite a bit lower" than many other fixed-income securities yet investors don’t give up some of the income potential. “One of the big risks is you’re dealing with a high yield-type credit quality,” he said. “But your duration should be under 90 days. And there are plenty of ways to play that in the ETF space both on the active and passive side.”
Covered Call Strategies
Investors who are more interested in equities can use covered call dividend strategies in the form of ETFs, Magoon said. These funds entail holding a long position in a security while writing, or selling call options on that same asset to try to generate additional income from that asset.
"An increase in volatility could be good for an options-based income strategy, while providing [downside] protection versus just being long only in those traditional market sectors," he said.
Infrastructure
Many people equate this space with high-yielding master limited partnerships, but some broader infrastructure-related ETFs pay 3 percent to 4 percent in yield, said Jim King, managing director at Guggenheim Investments.
The Guggenheim S&P High Income Infrastructure ETF (GHII), for example, which can invest in various infrastructure sectors ranging from energy and highways to electric utilities and water utilities, sports an SEC yield of roughly 5.5 percent. It trades with a net expense ratio of 0.45 percent.
Closed-End Funds
“Closed-end funds aren’t for everyone,” King said. “But I think an ETF wrapper is a wonderful way to own closed-end funds. They can be attractive from a yield perspective, but there’s also a visceral appeal about buying something at a discount.”
Closed-end funds often trade at a discount to net asset value, but they also tend to trade at discounts for long periods, meaning investors don’t always get the chance to buy at a discount and sell at a premium. And closed-end funds can be subject to bouts of illiquidity and volatility.
“So diversification is important,” King said.
One example of a collection of closed-end funds inside an ETF wrapper is the YieldShares High Income ETF (YYY), which tracks the ISE High Income Index comprised of 30 closed-end funds chosen for their combination of yield, discount to net asset value and liquidity. The fund’s 30-day SEC yield is 7.61 percent, but its carries a high expense ratio of 1.72 percent, with much of that being the cost of the management fees of the underlying closed-end funds.
Another fund in this category is the PowerShares CEF Income Composite Portfolio (PCEF), which tracks the S-Network Composite Closed-End Fund Index of roughly 140 closed-end funds. It has a 30-day SEC yield of 6.89 percent and a total expense ratio of 2.02 percent, with three-quarters of that being embedded management fees from the underlying closed-end funds.