by Lawrence Meyers | June 19, 2014 8:42 pm
High-yield ETFs that have mega-high yields are very tempting. Anything offering a dividend yield above 10% always gives me pause, because there’s got to be a reason that the payout is so high. In cases like BDCs or mREITs, it’s because they are leveraging really low interest rates to lend out or sell securities at higher yields. In other cases, the stocks have been beaten down to the point that the yield has risen to a level that may be unsustainable.
I decided to go on a hunt for the highest high-yield ETFs I could find, because ETFs would offer some safety in their inherent diversification. If a few stocks in the ETF imploded, the entire ETF may not go down with them.
I found three ETFs that offer diversification but also carry their own risks. After careful evaluation, I feel these dividend yields are safe for the foreseeable future. Any danger of implosion is likely to be telegraphed.
UBS E-TRACS 2x Wells Fargo Business Development Company ETN (BDCL) is a play on the Business Development Company concept just referenced. BDCs are entities that raise equity through the public markets via IPO, or borrow money at attractive rates, and then turn around and invest their capital into what are known as “middle market companies”. These are companies with a modest track record of producing reliable cash flow, that are already carrying a lot of debt and need to raise a lot more capital to finance their rapid growth. Banks usually won’t lend to them due to new restrictions on lending to businesses already in debt, so BDCs step in and offer financing in the 11% – 15% range and even take a small equity position. They must pay 90% of their income as a dividend.
This ETN uses a 2x leverage feature, so it exactly tracks twice the value of its underlying assets, as represented by the Wells Fargo Business Development Company Index, consisting of over two dozen BDCs. You are well insulated against disaster here, barring a major economic meltdown that torpedoes many of the companies the BDCs themselves invest in. It yields 16.32%.
iShares Mortgage Real Estate Capped ETF (REM) is a basket of mortgage REITs. These are companies that generally pull down cheap debt to purchase baskets of mortgages that pay higher yields. 90% of these mortgages are federally insured, while the other 10% consists of commercial mortgage financing, industrial and office REITs.
REM offers a high dividend yield because it holds two high-yield mREITs as major components of its basket of securities – Annaly Capital Management (NLY) and American Capital Agency Corp. (AGNC). Yet it is well-diversified with 36 holdings. The 15 % yield feels relatively safe because of something called “arbitrage”. Shares can be redeemed or created in 50,000 share lots. If the price drops, more shares can be purchased to be redeemed if NAV is significantly above market price.
iShares MSCI Colombia Capped ETF (ICOL) is a bit of an odd bird. It invests in a basket of Colombian equities Colombia is shaping up to be one of the big growth stories of the next decade. With the cartels now gone, and the government pushing to make it more attractive for tourists, and overall economic improvement, it’s a good place to be for international equity exposure.
The ETF holds only ten stocks, representing the largest energy, financial, materials, utility and consumer staples companies in the country. It’s not as diversified as I’d like, but time will likely result in more companies being added.
The ETF makes irregular monthly distributions, and at present, the distribution yield is 14.92%. The big risk here is political instability, but with Democratic elections being held, this seems unlikely.
Lawrence Meyers does not own shares in any security mentioned.
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