The explosion of ETFs, especially high-yield ETFs, in the stock market has provided investors with one of the best routes ever to create a diversified portfolio. ETFs offer instant diversification, and that spreading of risk creates a higher degree of safety. You could hold nothing but ETFs in your portfolio and be well-diversified for the long term, and have every sector covered.
High-yield ETFs are particularly attractive, especially to retirement investors. In retirement, one’s appetite for risk declines substantially while the need for income increases. High-yield ETFs provide the decreased risk while also paying out the income required.
The trick for high-yield investors has been how and when to chase yield. Attractive high-yield yields have been tougher to obtain, as bond investors have flooded the dividend market thanks to the Fed’s quantitative easing program, which pressured bond yields. Going further out on the risk curve is not what most retirement investors seek.
Fortunately, there are high yield ETFs that fit the bill.
UBS E-TRACS Wells Fargo Bus Dev Comp ETN (NYSEARCA:BDCS)
UBS E-TRACS Wells Fargo Bus Dev Comp ETN (NYSE: BDCS) is a great high yield high-yield ETF selection. The fund invests in a basket of Business Development Companies (BDCs) that throw off big dividends. BDCs are a particularly attractive investment for dividend hunters. These are companies that borrow funds at low interest rates, or raise money via equity, and then invest it in rapidly-growing companies in the ‘middle market”.
The middle market represents companies that have established solid cash flow and a viable business, but need more cash to fund rapid growth. They may have exhausted bank credit lines already, or banks view them as having too much risk. BDCs step in and fill the gap. They will take on senior or subordinated debt and earn from 11 – 17% on the investment, as well as take a small equity position in the company.
The risk is that a BDC will make one or more very poor investment choices and lose a lot of money.
BDCs are required under law to pay out 90% of their net income, just like REITs do. Most of these distributions occur quarterly, and many can run over 10% annually.
BDC stock is great because while any given BDC may implode as a result of bad investment decisions, it’s unlikely a basket of them will. Thus, the diversification provides safety…along with a 7.49% yield.
iShares US Preferred Stock (NYSEARCA:PFF)
iShares US Preferred Stock (NYSE:PFF) invests in a large basket of preferred stocks. Preferreds are attractive because they have qualities of both bonds and stocks. They trade like stocks, yet holders of preferreds are in front of common stockholders to collect back their principal if the company goes bankrupt.
In addition, if the company has to suspend dividends, it must suspend common dividends before preferred dividends.
Preferreds often trade in a very tight range, so there is little volatility. Companies that are financially solid will often have preferred shares that offer high yields. The PFF basket yields 6.52%, and holds many world-class financial stocks that are unlikely to experience trouble.
These include preferred shares of Barclays (NYSE:BCS), Wells Fargo (WFC), Citigroup (C) and Bank of America (BAC).
SPDR Barclays High Yield Bond (NYSEARCA:JNK)
SPDR Barclays High Yield Bond (NYSE:JNK)invests in a basket of junk bonds, but don’t let the word “junk” fool you. It doesn’t imply bonds that are going to default, but bonds that are not rated as highly as others. In order for a company to default on a bond payment, it must be in big trouble as a going concern.
If enough questions surround the viability of the company that when it issues debt, it must pay higher interest rates. That means higher yields for bond investors, and ETFs that invest in high yield instruments.
The ETF holds over 700 securities, and the largest holding only represents 0.77% of the fund. So any individual implosion is not going to take down the entire ETF.
It yields 5.79%
Lawrence Meyers owns shares of PFF.
This article is brought to you courtesy of Lawrence Meyers from Wyatt Investment Research.