With interest rates sitting at historic lows, finding stable sources of high income remains the top priority for many investors, especially those who are entering their golden years.
The go-to income investment for many portfolios has traditionally been U.S. Treasury bonds. Their safety and security has been well touted by the financial industry, and the bulk of investors' money still sits in broad-based Treasury funds and indexes. Exchange traded funds (ETFs) like the Vanguard Total Bond Market ETF and iShares Barclays Aggregate Bond, hold a combined $128-billion in investors' money.
Nevertheless, given that the hunt for income is becoming such an important piece of portfolio construction, investors just focusing on Treasury bonds are doing their portfolios a major disservice. Luckily, the proliferation of new exchange traded funds can provide just what these investors are looking for – high, stable sources of income.
The Search for Yield
With the global economy sluggishly plodding along and the Federal Reserve hinting at another round of quantitative easing, low interest rates are surely here to stay for a while. That's quite a problem for the millions of baby boomers who are getting ready to retire. Traditional CDs and money market funds are paying next to nothing and Treasury bond yields are barely compensating for inflation. All of these factors put pressure on a portfolio's ability to generate income and yield, right when the majority of investors need it the most.
Exchange traded funds are daily trading baskets of bonds and stocks that offer plenty of choices to help retirees find new income solutions. Their targeted nature allows investors to directly add asset classes not found in broad Treasury funds or indexes. That could lead to other opportunities for yield, as well as provide access to uncorrelated and often-ignored bonds. Likewise, the generally low expenses of ETFs make them perfect for income-oriented portfolios, as these fees allow investors to keep more of those critical dividend payments. Add in intraday tradability and you have a recipe for retirement income success.
Adding Some Spice
For those investors who prefer to stick to the safety of the U.S. government, agency bonds could be a way to get additional yield. At their core, agency bonds are issued by various government entities, such as mortgage lenders Ginnie Mae and Freddie Mac. Agency bonds are essentially backed by the full faith and credit of the U.S. government. Thanks to this government affiliation, agency bonds receive favourable treatment in several cases, including being exempt from most state and local taxes. The broad-based iShares Barclays Agency Bond ETF offers investors exposure to this area of the market. The fund offers a 1.4 per cent yield, which at first glance may seem low. However, given the fund's low duration, that number is higher than similarly weighted treasury bonds.
While most investors are familiar with tax-free municipal bonds, taxable munis do exist and these bonds could offer high, juicy yields. Created under the American Recovery and Reinvestment Act, Build America Bonds were designed as a way for states to help tap the constrained credit markets. When a government issues a BA Bond, it receives a cash subsidy from the federal government equal to 35 per cent of the coupon rate on the bond. In exchange for that interest subsidy, Build America Bonds are taxable. With nearly $1-billion in assets, and offering a 4.86 per cent yield, the PowerShares Build America Bond ETF should be investors' first stop to gain exposure to the asset class.
Just like companies in the United States, international firms need to tap the credit markets to raise money. Looking abroad for corporate bond exposure could pay off in a big way. The first ETF in this sector was the SPDR Barclays Capital Intl Corp Bond. The fund tracks a basket of investment-grade issuers and yields 2.31 per cent. Likewise, there are plenty of strong corporate contenders in the emerging market space that can be tapped via the new WisdomTree Emerging Markets Corporate Bond ETF.
The Bottom Line
The hunt for income remains a top priority for many investors these days. However, most bond portfolios barely hold anything except U.S. government bonds. That's a real shame, as there are plenty of additional options out there. Luckily, the ETF boom has made it easy for portfolios to add additional bond asset classes to an income portfolio. The previous examples are just a few of the many ways to do that.
At the time of writing, Aaron Levitt did not own any shares in any company mentioned in this article.