The Federal Reserve, as expected, raised official interest rates this week, and pledged to do so again this year.
Some investors have been cheering this latest move, and the broader trend. The S&P 500 Index (.SPX) has edged slightly higher this week around the Fed’s move. But a little history lesson is in order, because the reality is that even this “hawkish” positioning from the Federal Reserve has a long way to go before it puts us back in the land of normalized monetary policy and interest rates.
Consider that the 50-year average for the benchmark fed funds rate is about 5.3%, roughly three times the low-end of the current range. And while the latest increase continues to take us farther from ZIRP, it only puts us a hair above prior lows set briefly back at the end of 2003.
Of course, folks who rely on interest-bearing assets like bonds or CDs for income don’t need this history lesson. They’ve been suffering through with 2% or 3% rates for almost a decade now in everything from investment-grade corporates to Treasury notes.
As the Fed raises rates off the bottom, then, investors have two options.
The first is that they can continue to hang tight and wait for the Fed to slowly push rates higher, and hope that eventually it will translate to better yields.
But the second is to look for higher yields in the here and now, by exploring assets beyond Treasurys.
Here are a few ways to get yields north of 5% without taking on more risk than you’re comfortable with.
Three safer high-yield investments
To be clear, there is nothing that is truly a “safe” alternative to U.S. Treasurys or corporate bonds held by an AAA-rated tech behemoth like Microsoft (MSFT). However, the 10-year T-note has struggled to stay above 3% despite interest rate increases, and Microsoft yields a paltry 1.7% via dividends and a 3.3% coupon on its 10-year bonds issued just over a year ago.
Still, some alternatives are out there to supercharge your income potential without making incredibly risky bets.
Covered calls: For starters, every investor should consider covered calls as a way to deliver extra income. This strategy involves selling the option to purchase shares of the stocks you own to a third party, at a fixed price and date in the future.
It is truly a low risk approach, since the “worst” outcome is that your underlying stock soars and you leave some upside on the table as the options purchaser cashes in. But if the stock falls or the strike is never hit, you keep your shares as well as payment from the third party, whether they exercise the options or not.
There are some catches here, of course. The “yield” you generate depends on liquidity in the options, the prices and timeframes you set and how many shares you own. Options are sold in 100 share blocks, so sadly a small odd lot of shares won’t cut it. But there are a host of education resources out there, and brokers are quite competitive right now when it comes to keeping the costs of this strategy down.
Gold covered calls ETF: Intimidated by do-it-yourself options? Then the X-Links Gold Shares Covered Call ETN (GLDI) is an intriguing and mostly uncorrelated income play.
This exchange traded product holds physical gold bullion like some of the more popular gold funds out there, but the twist is it constantly sells covered call options on that gold for a regular income stream.
Gold is a (mostly) uncorrelated asset to begin with, and the current annualized yield of 5.1% makes this an intriguing piece for a diversified income portfolio.
Midstream MLPs: If either of those alternatives are too arcane, consider a straight dividend play in midstream MLPs like Cheniere Energy Partners (CQP).
This stock is an MLP that is largely insulated from energy price volatility, as it owns and operates the critical Sabine Pass liquefied natural gas terminal on the Gulf of Mexico. Think of it as a “toll taker” running a piece of midstream energy infrastructure between natural gas companies and the potential global export market.
Natural gas exports increased four-fold in 2017, and the fracking boom looks to continue that trend. With a yield of 6.6% currently and this big tailwind behind it, CQP should continue to hold steady and throw off big distributions for the foreseeable future.
Three moderately risky high-yield investments
If you don’t mind a little more spice in your life in pursuit of yield, there are no shortage of 5%-plus options out there. But here are a few of my favorite trades right now:
Big telecom: Telecom megacap AT&T (T) may not be perfect, but it is almost too much of a bargain to overlook right now.
After a steep sell-off in the wake of its proposed $85 billion merger with Time Warner moves closer to completion, the yield has leaped to 5.8% and the forward price-to-earnings (P/E) ratio is now in the single digits. Sure, there are serious risks to growth. But do you really think AT&T is going bankrupt anytime in the next decade or that it won’t be able to meet its dividend obligations with a payout ratio that is less than 60% of next year’s earnings?
BDCs: Another play that has its downsides but seems too good to pass up is the BDC space, short for “business development company.” These publicly traded stocks operate largely like private equity funds, gathering capital and deploying it in whatever investments they think make sense.
A good example is TPG Specialty Lending (TSLX) a pick that yields 10% thanks to targeted loans to mid-sized corporations. Shares of TSLX have been remarkably stable since their 2014 IPO, and the yield has been great.
Of course just a few poorly selected loans or a broad economic downturn that hampers repayment could be painful. So be aware of this.
Junk bonds: When we talk about yield, it’d be a big oversight to simply look past one of the most popular high-yield investments out there — the iShares iBoxx High Yield Corporate Bond ETF (HYG). This fund has 30-day yield of 5.8% and a massive $15 billion in assets under management.
There is always hand-wringing about how the junk bond market may be doomed, either as higher rates continue to squeeze bond principle values or the economy slows or a “maturity wall” makes rolling over existing debts impossible for sub-par companies.
But the death of junk has been greatly exaggerated in the past, and the yields continue to be pretty darn good.
Three aggressive high-yield investments
Leveraged dividends: An exchange-traded pick that has done very well for investors lately but has potential for volatility is the UBS ETRACS Monthly Pay 2x Leveraged S&P Dividend ETN (SDYL).
The name is a mouthful, but a careful reading explains most of it: This is a fund that pays you over 30 days, using “leverage” to roughly double the yield of the S&P 500. In truth, this ETN doesn’t invest completely in the S&P 500 but instead focuses on the “dividend aristocrats” in the index — companies that have increased payouts for each of the past 25 years. SDYL delivers 5.3% yield at present all the while delivering an impressive 10% capital appreciation in the past 12 months.
Just remember that even dividend stocks can roll over — and that the leverage deployed in this fund drives up management costs as well as exposes you to volatility in both share price and distributions.
Closed-end funds: Don’t like what you see in conventional bond funds? Well, closed-end funds often offer better income potential, and can operate with fewer limitations.
One such example is the Pimco Dynamic Credit and Mortgage Income Fund (PCI) that trades in agency mortgages, corporate debts, foreign bonds and everything in between. It then uses financial instruments similar to SDYL to supercharge its returns. The result is a massive 8.3% yield and a fund that has managed to slightly outperform the broader S&P 500 this year.
Just remember that you’re at the mercy of the manager. And as a sister to conventional bond funds, the rising-rate environment and trouble with credit either in Europe or in the junk bond space can spill over here too.
Emerging market debt: If you really want to take the tiger by the tail, you can consider going all-in on emerging market debts via a fund like the iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB).
Some still think that a lot of pain is coming for these governments as higher rates draw capital back into the U.S. after these regions enjoyed (comparatively) easy money for the past decade. However, global growth remains pretty decent and a fund like EMB is diversified across geographies. Mexico and Indonesian debt top the list at only 6% and 5% weightings, respectively.
With a 30-day yield of 5.4%, this fund may be worth a look if you don’t buy into the fears that the Fed’s moves will kill emerging markets. Or if, perhaps, you don’t necessarily believe that U.S. rates will move as high or as quickly as others.
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