Income investors that have sought out alternatives to traditional dividend stocks and fixed income have largely been rewarded this year. Asset classes such as MLPs, REITs and preferred stocks offer attractive qualities — namely, their combination of high yields and non-correlated returns.
Most investors tend to flock to the oldest and largest dividend ETFs in these respective categories. That’s understandable: After all, these funds are well-known and have been used successfully in the past or they represent the most diversified mix of underlying securities.
Plus, in many cases, these funds also are the most heavily traded, which provides excellent liquidity and execution when buying or selling.
However, in researching these areas I came across several smaller dividend ETFs that have surpassed their more established peers in 2014. I think they warrant a second look if you are considering alternative income sources.
Dividend ETFs to Buy: First Trust North American Energy Infrastructure Fund (EMLP)
Class: Master Limited Partnerships
Distribution Yield: 3.4%
In the world of master limited partnership ETFs, the Alerian MLP ETF (AMLP) is the reigning king. AMLP has nearly $8 billion invested in a relatively concentrated portfolio of 25 holdings and pays a high yield north of 6%. So far in 2014, this ETF has returned 2.3% on the back of strong support for oil and natural gas prices.
One worthy competitor to AMLP is the First Trust North American Energy Infrastructure Fund (EMLP), which is an actively managed ETF with a more diversified base of 55 energy companies in its portfolio. EMLP has jumped more than 6% this year due in large part because it has 30% of the portfolio dedicated to traditional utility stocks. The utility sector is the leading market segment so far in 2014, and certainly EMLP has benefited from that exposure.
The one drawback to this difference in underlying holdings is that the yield on EMLP is just 3.21% because it is not fully dedicated to the MLP theme. However, EMLP charges just 0.95% in expenses, which is just a fraction of the hefty 4.85% fee that AMLP charges on an annual basis.
Dividend ETFs to Buy: iShares Residential Real Estate Capped ETF (REZ)
Class: Real Estate Investment Trusts
Dividend Yield: 3.7%
Another hot sector this year has been real estate investment trusts, or REITs. Stabilizing interest rates and strong housing data has renewed support for this income generating asset class.
The largest ETF in this space is the Vanguard REIT ETF (VNQ) which invests in a broad portfolio of 132 commercial, residential, and specialty REITs. So far this year, VNQ has increased in value nearly 12%.
While that performance is certainly excellent, one subsector has posted even stronger returns in 2014.
The iShares Residential Real Estate Capped ETF (REZ) focuses on a narrow portfolio of 35 REITs in residential and specialty units and charges just 0.48% for the trouble. REZ, which has a 30-day SEC yield of 3.7%, has gained nearly 15% this year.
Clearly, this dividend ETF’s targeted exposure has been able to enhance returns compared to a broad-based benchmark.
Dividend ETFs to Buy: MarketVectors Preferred Securities ex Financials ETF (PFXF)
Class: Preferred Stocks
Dividend Yield: 6.1%
The last alternative dividend ETF that warrants a mention is preferred stocks.
I have owned the iShares Preferred Stock ETF (PFF) for myself and my income clients for some time now. This fund is easily the largest in its class with more than $9 billion in total assets and a yield of 5.8%. One attractive feature of this sector is that income is paid monthly to shareholders. So far this year, PFF has jumped nearly 8% after catching a tailwind from falling long-term interest rates.
Another option to consider in this arena is the Market Vectors Preferred Securities ex Financials ETF (PFXF). This dividend ETF holds a unique mix of preferred stocks of non-financial companies which is largely centered on REITs, utilities and telecoms. In 2014, PFXF has gained 9.6% and also offers a slightly higher yield of 6.1%. It’s also slightly cheaper, at 0.4% in expenses to PFF’s 0.48%.
Similar to REZ, this fund benefits from more focused exposure to a subset of the preferred stock universe that has outperformed a broader index. A dividend ETF like this might be more suitable as a tactical opportunity rather than a core holding, but certainly merits a close look for monthly income seekers.
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David Fabian is Managing Partner and Chief Operations Officer of FMD Capital Management. As of this writing, he was long PFF and VNQ. Learn More: Why I love ETFs, And You Should Too.