Here are Barron’s 12 best income investments for the new year

  • By Andrew Bary,
  • Barron's
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While it might not be a feast now for income-oriented investors, it’s a lot better than the famine that prevailed for much of the past decade.

Yields on a range of bond and bond-related investments rose by two to four percentage points during 2022. So, investors finally stand to earn positive inflation-adjusted returns, assuming the consumer price index continues its retreat from the 8% reading prevailing at midyear.

Investors can get 3% to 5% yields on municipal bonds, 8% to 9% yields on junk debt, 6% to 8% on preferred stock, and 4% on risk-free short-term Treasuries.

Within the stock market, there are yields of 5% to 9% on pipeline companies, 6% on telecom operators, 4% on real estate investment trusts, and 3% on utilities and a broad group of dividend-paying companies, including big banks.

Bonds are coming off one of their worst years in decades, with the broad iShares Core U.S. Aggregate Bond exchange-traded fund () returning negative 13%. Long-term Treasuries were down 30%.

This has prompted many investors and financial advisors to question the value of bonds in portfolios and the wisdom of the traditional 60/40 mix of stocks and bonds. But looking backward is the wrong way to approach bond investing. The outlook has rarely been better in the past decade.

“With bonds, it’s where you start that counts,” says Bryn Torkelson, president of Matisse Capital, which runs the Matisse Discounted Bond closed-end fund (). He sees closed-end opportunities throughout the bond market.

“Absolute yields are finally at attractive levels. We’re in a good spot to earn positive returns in 2023,” says Nisha Patel, a managing director in the municipal bond group at Parametric, a division of Morgan Stanley.

While she is speaking about munis, the statement could apply to the entire bond market.

Each year, Barron’s ranks 12 sectors of the stock and bond markets, based on our view of their relative appeal. We did pretty well with our 2022 selections, as the sectors we favored—energy pipelines, dividend-paying stocks, and electric utilities—outpaced groups such as preferred stocks, taxable munis, and Treasuries.

This year, we again favor pipelines. We also like dividend-paying stocks in the U.S. and abroad, REITs, and convertible debt. Here is a look at a dozen income-generating sectors, and specific ways to gain exposure to them.

Energy pipelines

Energy pipelines had a strong 2022, and the outlook is good for 2023, as companies continue to emphasize capital discipline and dividends. Yields range from 5% to 9% for major operators.

The Alerian MLP ETF () returned 25% in 2022, and closed-end funds were up 20% to 40%, reflecting the rally in the sector and some narrowing of what had been huge, 20%-plus discounts to net asset value.

“These are essential businesses,” says Rob Thummel, a senior portfolio manager at TortoiseEcofin. “The U.S. needs oil, gas, and natural-gas liquids for daily living—and so does the world.”

Thummel ticks off some positives: Free-cash-flow yields are close to 10%, dividends are well covered by free cash flow and growing at an average rate in the mid-single digits, and debt levels are manageable. Capital spending is modest because the U.S. pipeline network is largely built out—and getting approvals for new projects is difficult, putting a premium on existing infrastructure.

Investors can get exposure to the sector through companies such as Williams Cos. (), Kinder Morgan (), Enterprise Products Partners (), and Energy Transfer (), as well as the AMLP ETF, now yielding 8%. Corporate structures are favored by investors over master limited partnerships, due in part to easier tax reporting.

Williams, a major transporter of natural gas, is a Thummel favorite. The long-term U.S. gas outlook is good, due to the growth of liquefied-natural-gas exports and the reshoring of manufacturing. As the purest gas play among the major pipelines with a corporate structure, Williams has one of the lower yields, at 5%.

Even with the rally over the past year, pipeline closed-end funds still trade at 10%-plus discounts to net asset value and yield an average of about 8%. The Tortoise Midstream Energy fund (), for instance, trades for a 20% discount to NAV and yields 9%.

U.S. dividend stocks

Higher-dividend stocks did their job in 2022 and held up much better than the S&P 500 index () The benchmark Vanguard High Dividend Yield ETF () was unchanged, including dividends, against an 18% negative return for the S&P.

The performance reflects strength in several sectors—energy, consumer staples, healthcare, and utilities—well represented in dividend strategies. That shows why dividend-paying stocks deserve a prominent spot in income-oriented portfolios.

There are plenty of ways to invest in the group. The $50 billion Vanguard High Dividend Yield fund () is weighted toward the largest dividend payers, such as Johnson & Johnson (), Exxon Mobil (), and JPMorgan Chase (). Its yield is 3%, almost double the S&P 500’s.

The $44 billion Schwab US Dividend Equity ETF () has a 3.1% yield and counts among its larger holdings Merck (), Amgen () and IBM (IBM). The lower-yielding ProShares S&P 500 Dividend Aristocrats () focuses on companies with 25 years of annual payout increases. Its largest holdings include Cardinal Health (), Archer-Daniels-Midland (), and Chevron ().

Banks now are one of the best sources of income in the stock market, after declining about 25% in 2022.

Regionals such as U.S. Bancorp () and PNC Financial Services Group () yield about 4%, while JPMorgan Chase yields 3%, and out-of-favor Citigroup (), 4.6%. The Invesco KBW Bank ETF () yields 3.2%.

The Dow Jones industrials () also feature high yielders, including Intel () and Dow (), the chemical maker. Both yield about 5.5%.

Foreign dividend stocks

Overseas stocks have long been a good source of income. Companies outside the U.S. tend to emphasize dividends over stock buybacks and often have high payout ratios of earnings. Big European stocks, for instance, yield an average of 3.5%, double the S&P 500.

The problem for U.S. investors is that international stocks have badly lagged behind American equities over the past 10 years, with the iShares MSCI EAFE ETF (), a broad non-U.S. index, rising less than 5% annually, versus nearly 13% for the S&P 500.

After this historic underperformance, the coming decade could favor non-U.S. stocks, due in part to lower valuations internationally and a possible weakening of the dollar.

There are several dividend-oriented ETFs geared toward overseas stocks, such as the iShares International Select Dividend () with holdings in stocks such as Rio Tinto () and TotalEnergies (), and the Schwab International Dividend (), which counts among its bigger investments Unilever () and BAE Systems ().

Nearly all major international companies pay dividends, including Nestlé (), Toyota Motor (), and Novartis (), which generally have secure 2%-plus yields.

One nice thing about major United Kingdom companies such as Shell (), Unilever, and BAE is that there is no withholding tax on their dividends. One drawback is that many international companies have profit-linked dividends, making them less predictable than those from big U.S. companies.

Real estate investment trusts

Real estate stocks were hit hard in 2022, despite ample rent increases industrywide. Investors repriced the sector based on higher rates and concerns about a possible 2023 recession.

The sector now offers an appealing combination of yield and potential capital appreciation. The largest ETF, the $33 billion Vanguard Real Estate (), is down 26% in 2022 (including dividends) and has given back all of its 2021 gains. Yielding nearly 4%, it counts among its largest holdings warehouse operator Prologis () and American Tower (), the biggest owner of cellphone towers.

Rent increases are moderating, but REITs generally have strong balance sheets and free cash flow.

Analysts at Green Street Advisors view the sector favorably, with most of its members trading below the firm’s estimate of net asset value. Hard-hit apartment REITs, such as AvalonBay Communities () and Equity Residential (), look particularly cheap, based on Green Street’s analysis, after dropping 35%. They yield about 4%.

Piper Sandler analyst Alexander Goldfarb is partial to Mid-America Apartment Communities (), which has a Sunbelt focus, unlike the mostly coastal AvalonBay and Equity Residential. “Retail, industrial, and Sunbelt apartments are strong,” he says. Technology layoffs, he adds, are concentrated on the coasts: “This is a white-collar recession.”

In retail, he favors strip-mall operator Kimco Realty (), noting that there has been little new construction in the sector in the past decade and that Americans are shopping in stores again. He also likes EastGroup Properties () among warehouses, saying the outlook for e-commerce looks healthy, despite cutbacks at industry leader Amazon.com ().

Convertible bonds

Convertibles are supposed to deliver the upside of stocks and downside protection of bonds. But they didn’t protect investors in 2022, as the ICE BofA U.S. Convertible index returned a negative 18.5% through Dec. 23, in line with the S&P 500.

The poor showing reflects the impact of higher interest rates and a sharp selloff in shares of midsize growth companies, which are considerable convertible issuers.

The setup for 2023 looks better because convertible prices are down, lifting average yields to about 2.5% and offering more security to investors.

“The market has turned 180 degrees,” says Howard Needle, a portfolio manager at Wellesley Asset Management, a convert specialist. “Convertibles offer a conservative way to play the equity market.”

Investors can access the $250 billion sector through the $4 billion SPDR Bloomberg Convertible Securities ETF (). There are open-end mutual funds, such as the $800 million Miller Convertible Bond fund (), and closed-ends, such as Advent Convertible & Income AVK), quoted at a 10% discount to its NAV.

Among individual issues, Needle is partial to Ford Motor ’s () zero percent convertible bond due in 2026 trading around 95 cents on the dollar and offering a yield of 1.5% and a 35% conversion premium.

Barron’s has highlighted a group of busted convertible bonds now trading around 50 that often carry double-digit yields and offer a lower-risk alternative to depressed common shares.

Issuers of these include MicroStrategy (), Coinbase Global (), Peloton Interactive (), Wayfair () and DraftKings (). Coinbase’s 0.5% convert due in 2026, for instance, trades for under 60 cents on the dollar and has a yield to maturity of 18%.

Junk bonds

Junk-bond yields have risen to more than 8.5% from 4.4% at the start of 2022, based on the ICE BofA US High Yield Index, a move that finally puts the “high” back into what is euphemistically known as the high-yield market.

There is a debate about whether the current yields compensate for the risks, with a recession possible in 2023. The spread versus Treasury yields is 4.5 percentage points, in line with the 10-year average. The bearish argument is that average yields could approach 10% in a downturn. (Bond prices move inversely to yields.)

“People think high-yield spreads are fairly tight, if we’re indeed entering a recession,” says Sebastien Page, head of global multi asset at T. Rowe Price . “However, historical comparisons aren’t that useful because high yield is a higher-quality asset than it used to be, if you look at the distribution of ratings.”

One positive is that issuance plunged by 70% in 2022, meaning there’s less new supply. That trend is expected to persist into the new year.

Junk-bond yields range from just above 6% for well-regarded Charter Communications () to about 15% on highly leveraged Carnival ().

The $16 billion iShares iBoxx High Yield Corporate ETF (), a good junk-market proxy, returned negative 11% in 2022. Given much higher starting yields now versus those available a year ago, there is a good chance the sector will have positive returns in 2023.

Investors with more risk tolerance can buy leveraged, closed-end junk funds, such as BlackRock Corporate High Yield (). It returned negative 22% in 2022, but could have double-digit positive returns in 2023 if the market recovers. At about $8.50, it yields more than 10%, trades at a 7% discount to NAV, and holds bonds from companies such as Uber Technologies () and Clear Channel Outdoor Holdings (), the billboard operator.

Another way to play the market is via leveraged loans, which carry floating rates, and thus less rate risk. The closed-end Nuveen Credit Strategies Income fund (), which invests in the area, yields 11% and trades at a 13% discount to NAV.

Municipal bonds

Municipal bond yields are up by two percentage points or even more over the past 12 months, enhancing the appeal of what is probably the most popular fixed-income market for individuals.

Depending on maturity and credit quality, yields now are in the 2.5% to 5% range. “Tax-exempt yields are near the highs of the past decade. They offer attractive levels of income with defensive credit characteristics if the economy slows more than expected in 2023,” says David Hammer, the head of municipal bond portfolio management at Pimco.

High-quality munis have experienced very low historical default rates because issuers provide essential services such as water or highways, or have the taxing power of state and local governments.

The better values in municipal bonds are in long-term issues with maturities of 20 years or more. Shorter-maturity issues, such as five-year bonds, offer less appeal, relative to Treasuries, after taxes.

Hammer is partial to 4% long-term bonds, such as those issued by the New York State Dormitory Authority, with double-A ratings due in 2048 and now yielding 4.5%, or the San Diego Airport bonds with single-A ratings due in 2046 at 4.75%. These yields exceed those of long-term Treasuries at 4% and are equivalent to about 8% for in-state residents in the top tax brackets. A small portion of the yield on these bonds is taxable because of their discount from face value.

Hammer, who runs the Pimco High-Yield Municipal Bond fund (), says that lower-rated munis look appealing. He points to the $3.5 billion Puerto Rico Cofina 5% issue due in 2058. It yields about 5.5%

Depressed closed-end muni funds, including Nuveen AMT-Free Quality Municipal Income (), are down about 25% this year, yield close to 5%, and trade at roughly a 10% discount to net asset value. Their leverage hurt returns in 2022, but it would magnify gains if the market rallies in 2023.

Preferred stocks

The $350 billion preferred market looks more appealing after yields within it rose about two percentage points during 2022, to a range of 6% to 9%.

The dividends look secure. Banks, the major issuers, have ample earnings and capital, which should enable them to get through a potential economic downturn.

While preferreds rank below debt in corporate capital structures, companies are loath to omit dividends. The sector has long been popular with income-oriented investors, due to its combination of yield and liquidity; most issues trade on the NYSE like common stocks.

The group’s largest exchange-traded fund is the iShares Preferred & Income Securities (), now yielding 6.1%.

Among bank preferreds, the JPMorgan 4.2% issue yields 6%, and the Wells Fargo 4.75%, about 6.5%. AT&T’s 4.75% issue yields 6.7%.

Barron’s recently highlighted preferred shares issued by real estate investment trusts. Public Storage () is the largest REIT issuer, and its preferred yields about 6%. Higher yields around 8% are available on preferreds from mortgage REITs, such as Annaly Capital Management () and AGNC Investment (), and hotel REITs, including Pebblebrook Hotel Trust ().

Telecoms

It has been a tough few years for wireless telecom-industry leaders Verizon Communications () and AT&T (), as competition has intensified from upstart T-Mobile US () and cable operators, while capital spending has remained high.

Verizon was the hardest-hit in 2022, as its stock returned a negative 21%, while AT&T was up 5%. T-Mobile continued to gain, rising 20%. Barron’s has favored T-Mobile because of its growth and network advantage, but it doesn’t pay a dividend.

Verizon and AT&T now offer some of the highest yields in the S&P 500. Verizon, at about $39, yields 6.7% and AT&T, at $18, 6.1%—marking a rare instance when Verizon yields more. Both trade for under 10 times projected 2023 earnings, and their dividends look secure.

The negatives were recently summed up by Craig Moffett of SVB MoffettNathanson: “slowing subscriber growth, rising industry promotionality, accelerating pressure from cable wireless,” and an expectation of declining growth and free cash flow for both Verizon and AT&T. Verizon, in particular, has been hurt by what Moffett calls “weakening perceived network advantage.”

Warren Buffett, whose Berkshire Hathaway , which held a 4% stake in Verizon worth $8 billion at the end of 2021, gave up on the company and sold all of its holding in 2022.

While not enthusiastic about Verizon, Moffett upgraded the stock to Market Perform from Underperform in December, and cut AT&T to Underperform from Market Perform, citing Verizon’s low stock price and weak performance.

Cash alternatives

Cash has become an appealing asset as short-term rates have risen from near-zero to more than 4%. Yields could hit 5% if the Federal Reserve continues to tighten monetary policy.

Investors don’t have to do much to get 4% yields now, with the $216 billion Vanguard Federal Money Market fund () yielding 4.2%.

“You can now earn a reasonable yield in cash, and that yield has even turned positive after you remove expected inflation,” says Page of T. Rowe Price.

There are plenty of other options. The SPDR Bloomberg 1-3 Month T-bill ETF () and iShares Short Treasury Bond ETF () yield over 4% and hold short-maturity Treasuries. The Vanguard Ultra-Short-Term Bond fund () takes a little more risk by holding corporate bonds maturing in less than a year. It yields more than 5%.

Berkshire Hathaway’s Buffett favors direct investment in ultrasafe U.S. Treasury bills, which have maturities of one year or less. Individual investors can participate in regular auctions of three-, six-, and 12-month bills, as well as those maturing in four or eight weeks. T-bills can be purchased on the TreasuryDirect website or through banks and brokers. The three-month bill now yields 4.2%.

One nice aspect of Treasury bills, relative to bank certificates of deposit and corporate debt, is that the interest they generate is exempt from state and local taxes. That’s a particularly big plus for investors facing punishing 10%-plus state and local tax rates in New York and California.

Treasuries

Treasuries offer reasonable yields for the first time in more than a decade. They provide a hedge against a drop in the stock market, while offering appreciation potential if inflation continues to recede.

Given the inverted yield curve, with shorter rates higher than longer ones, the two-year Treasury note yields 4.4%, against 4% for the 10- and 30-year issues. There is more risk—and potential upside—with the longer maturities.

Exchange-traded funds offer a good way to invest in Treasuries, including the iShares 1-3 Year Treasury Bond () and the iShares 20+ Year Treasury Bond (), with a fee of just 0.15% annually.

Treasury inflation-protected securities, or TIPS, could offer an even better deal than regular Treasuries, especially for those concerned about inflation. The current inflation “break-even” on most TIPS, relative to regular Treasuries, is just 2.3%.

If inflation is higher than 2.3%, TIPS will do better. While inflation, as measured by the consumer price index, already has declined from the levels around 8% seen in the summer, it might not drop as low as 2% anytime soon.

The iShares TIPS Bond ETF () offers a real, or inflation-adjusted, yield of nearly 2%, close to the highs of the past decade. The real rate was negative 1.5% at the start of 2022. With an average maturity of seven years, the TIP exchange-traded fund has more rate sensitivity than the iShares 0-5 Year TIPS Bond ETF ().

TIPS didn’t perform well in 2022, despite higher inflation, because real yields climbed, too. However, the risk/reward ratio looks much better now, with real yields closer to 2%.

Electric utilities

Utilities delivered for investors during a tough 2022, but they look richly priced going into 2023.

Historically defensive electric utilities were about flat in 2022, as gauged by the Utilities Select Sector SPDR ETF (). But they significantly outperformed the S&P 500 and the Treasury and corporate bond markets.

Utilities now appear expensive based on several measures, including dividend yields and price/earnings ratios. The group is yielding close to 3%, less than the 10-year Treasury and about half the rate on long-term utility debt. In the past decade, utility stocks have averaged about the same yield as utility debt.

It generally pays to buy utilities when they have similar or lower P/Es than the S&P 500, but leading companies such as Duke Energy (), Consolidated Edison (), Southern Co. (), and Xcel Energy () now fetch an average of close to 20 times projected 2023 earnings, against the S&P 500’s about 17.

Earnings and dividend growth in the sector should average in the mid-single digits annually in coming years as utilities invest in renewable power and transmission lines. This expansion should translate into higher profits, but there’s a caveat: Fatter earnings could produce regulatory pushback against requests for higher electric rates.

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