It seems everyone and their grandmother is on the hunt for dividend yield.
Which is funny — I think back only a few years ago, and nobody even knew what preferred stocks were, but the other day I overheard people talking about them at a burger joint!
When it comes to dividend stocks, we always want to make sure we are buying good investments, because a high yield might mask a terrible business. That’s why I like dividend exchange-traded funds, because they provide tremendous diversity. Even if a company or two were to completely implode in the ETF, it would hurt the fund, sure, but the impact likely would be minimal, and you’d certainly be better off than individually holding the company that went under!
I’ve found three nice choices for dividend ETFs that offer diversity both within each selection and across all three selections. Here’s a look:
ETRACS 2X Leveraged Long Wells Fargo Business Development Company Index ETN (BDCS)
The ETRACS 2X Leveraged Long Wells Fargo Business Development Company Index ETN (BDCS) is … well, it’s a mouthful, but it’s also one of my favorite dividend ETFs.
BDCS holds a basket of business development companies, or BDCs (hence the name). These are uniquely structured entities that, like REITs, must pay out at least 90% of their taxable earnings as dividends.
BDCs traditionally operate in what’s called the “middle market.” This is a place where companies land after they’ve moved past their start-up phase, past proof-of-concept, and actually have a product(s) that are generating revenue. The companies are growing rapidly, and they need capital to fuel that growth. BDCs often step in with lending capital, charging mezzanine-style rates, usually taking a senior position with the debt, and getting an equity kicker. The BDCs borrow their money from sources at much lower rates, so they profit off the arbitrage and if those equity kickers ever become worth anything.
BDCS yields a whopping 7%, but again, here’s the catch: This is a leveraged exchange-traded note, which in short means it’s designed to theoretically double the index it follows … but that means a rough time for this BDC index means a doubly rough time for anyone invested in it. You can catch up more on ETNs (exchange-traded notes) and how they differ from ETFs here, but in short, be careful with this product.
PowerShares S&P 500 BuyWrite Portfolio (PBP)
As far as dividend ETFs go, I have a fondness for PowerShares S&P 500 BuyWrite (PBP). That’s because it takes on a strategy I write about often.
The ETF holds a portfolio mostly comprised of stocks held in the S&P 500, then writes covered calls against the positions, using strike prices at or above where a given stock trades. The dividends and premiums earned get reinvested. Basically, the ETF doesn’t care if stocks get called away or not. They just repurchase them and write new calls.
PBP itself was up only 4% last year, so it obviously does not capture the upside of the bull market, but it does pay out a substantial 6.5% yield. So you are essentially trading off the risk of owning the S&P 500 long by selling calls against it all the time.
AdvisorShares Peritus High Yield ETF (HYLD)
AdvisorShares Peritus High Yield ETF (HYLD) allows you to own a diversified group of junk bonds. This dividend ETF holds, at last count, some 82 bonds that are well-diversified across 24 different sectors. Seventy percent of the ETF’s holdings are in bonds rated B+, B or B- by Standard & Poor’s.
HYLD’s average coupon is 9.28% vs the Barclays US High Yield Index’s average of 7.28%, with an average of 8.92% yield to maturity vs the index’s 6.1%. Also, at 2.62 years, HYLD’s holdings have a shorter duration than the index’s by about a year. The bonds’ average duration is 2.62 years vs. 3.66 for the index.
Of course, the yield is about all you’ll get from HYLD for the most part — at its most volatile, you’re looking at swings in the mid-single digits so far in its short history.
That all amounts to a very attractive yield well north of 7%.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities. He is president of PDL Broker, Inc., which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books and blogs about public policy, journalistic integrity, popular culture, and world affairs. Contact him at firstname.lastname@example.org and follow his tweets @ichabodscranium.