by Tom Taulli | July 12, 2012 2:31 pm
Dividend-paying stocks have certainly been popular. With the weakening of global markets, investors want to find safe havens. The problem is that dividend-paying stocks are far from foolproof. Just look at the big drops in blue chips like McDonald’s (NYSE:MCD) or JP Morgan (NYSE:JPM).
So what to do? One approach is to look at hybrid securities. These are essentially a blend of a stock and a bond.
One example is preferred stock. This represents ownership in a company, but it has more protection than common stock. A preferred stock also typically pays a higher yield.
There are also junk bonds. Yes, they provide fixed-income but are often issued by smaller companies, which may provide some growth potential.
To play these types of hybrid securities, a smart strategy is to look at exchange-traded funds (ETFs) and mutual funds. Here’s a sampling of some standouts:
iShares S&P U.S. Preferred Stock Index’s (NYSEARCA:PFF) portfolio holds mostly financial stocks (which tend to be the main issuers of preferred stock). Some of the top holdings include preferred issues from companies like HSBC (NYSE:HBC), Barclays (NYSE:BCS) and Wells Fargo (NYSE:WFC).
For the past three years, the average annual return was about 15%. PFF also sports a dividend yield of 6.45%.
Now, if the U.S. falls into a recession, the fund will inevitably suffer. Yet it should still do much better than equities. In 2008, PFF sustained a loss of 23%. The S&P 500, on the other hand, was down 37%.
A junk bond is a security that has a below-investment-grade rating. Basically, this means it has a higher probability of default, thus it has to offer higher yield to compensate for the higher risk. Despite this, history has shown that this usually isn’t a big problem if a fund has diverse portfolio of junk bonds.
And iShares iBoxx $ High Yield Corporate Bond (NYSEARCA:HYG) is one of the top ETFs in this category. It has about $15 billion in assets and has strong trading volume, which averages about 2.7 million shares per day. The expense ratio is also a reasonable 0.5%.
HYG is based on the iBoxx $ Liquid High Yield Index, which is focused on fairly liquid bonds. HYG has over 600 bonds in its portfolio.
The current yield on HYG is 6.57%. What’s more, the average annual return for the past three years was 15%.
HYG tends to focus on riskier bonds. But investors who want something more conservative may want to look at PowerShares Fundamental High Yield Corporate Bond (NYSEARCA:PHB). For the most part, it invests in higher-quality junk bonds.
But yes, that means a lower yield. The current payout is 5.23%. In all, PHB has about $976 million in assets and has an average trading volume of 554,774 shares a day.
Another way to help reduce the risk levels of a junk-bond portfolio is to get a fund with professional managers. And one of the best is the BlackRock High Yield Bond Fund (MUTF:BRHYX).
Portfolio manager Jimmy Keenan has proven to be adept at analyzing credit risk. However, he has had some stumbles, such as getting too aggressive with European bonds.
Yet Keenan has posted solid numbers. Over the past three years, the average annual return was 18%. What’s more, the current yield is 6.37%.
Tom Taulli runs the InvestorPlace blog IPO Playbook, a site dedicated to the hottest news and rumors about initial public offerings. He is also the author of the upcoming book How to Create the Next Facebook: Seeing Your Startup Through, from Idea to IPO. Follow him on Twitter at @ttaulli or reach him via email. As of this writing, he did not own a position in any of the aforementioned securities.
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