High-yield investments have been in fashion over the last few years mostly because the income potential elsewhere has just been miserable.
But while interest-bearing assets like government and corporate bonds aren’t exactly high-yield investments, it’s worth noting that the returns have been pretty handsome in 2014 nonetheless.
Consider the iShares Barclays 20+ Year Treasury Bond ETF (TLT) that is up about 16% year-to-date in 2014 — nearly double the returns of the S&P 500.
But don’t expect that to last.
The rise in principle for many bond funds in 2014 has been caused by a steady decline in interest rates; as rates fall, the value of bonds naturally rise because investors are willing to pay more for older debt with a better interest rate on it.
But with the end of quantitative easing at the Fed and overtures about a rate hike in 2015, it’s quite possible we will see those gains evaporate in the next 12 to 18 months.
Besides, most folks seeking high-yield investments aren’t interested in bonds or dividend stocks simply for an increase in their initial investment value. Dividend stocks, high-yield bonds and other similar high-yield investments are often considered because of their income potential across many years — not swing-trade potential.
So if you’re worried about income and looking for high-yield investments that the Federal Reserve won’t mess with as it tightens policy in 2015, here are five picks to consider.
High-Yield Investments — MLPs
MLPs or master limited partnerships are very popular among the income crowd, because these companies are structured in a way that guarantees any profit flows back directly to investors.
Sure, the weird jargon about MLP units and distributions instead of shares and dividends gets tiresome. And sure, the K-1 forms and unique tax structure that come with these partnerships can cause even a trained accountant to scratch her head.
But if you want reliable and significant income, MLPs are a great tool for your portfolio.
MLP Trades to Make Now
I particularly like “toll taker” MLPs that focus on midstream energy businesses. These energy companies don’t have to worry about the risks of energy exploration on the front end or refining and selling on the back end … they simply play middle man, with little exposure to commodity price fluctuations.
I also like the diversification of MLP funds that spread out your risk.
Thus, at the top of my list is the ETRACS Alerian MLP Infrastructure Index ETN (MLPI) because it focuses largely on this “toll taker” segment I mentioned, via pipeline and storage companies. Furthermore, only six holdings have an allocation of more than 5% and no component has a weighting of over 10% of the entire fund; other MLP funds are more top-heavy with their major components.
Based the last distribution of about 46 cents in October, this fund yields a nice 4%. As a bonus, the ETN is structure in a way that you avoid the headaches of K-1 tax forms, unlike direct investment in individual MLPs.
This MLP fund saw a big pullback in October with other energy plays, but has fought back and is now up 11% YTD on share price alone in addition to paying a good yield, so is worth a look.
High-Yield Investments — REITs
Like MLPs, real estate investment trusts are structured in a way that make them high yield investments; by law, 90% of taxable income must be returned to REIT shareholders.
The challenge, of course, is the balance between the desire for big yield in REITs and desire to avoid big risk if you’re truly looking for a bond-like alternative.
Among the different flavors of real estate investment trusts, I don’t trust REITs that deal with mortgage paper right now, because spreads could keep rising. Bigger spreads will act as an anchor on both book values and on dividend potential in these companies.
A much safer bet for income investors in my book, and one that I’ve touted before, are real estate investment trusts that focus on senior housing and health care businesses.
The demographic tailwind created by aging Baby Boomers that need more care and the rise in insurance coverage thanks to Obamacare will mean more business for medical offices, physical therapy centers and other facilities. If you can find a REIT that owns or leases these kind of healthcare properties, it’s a great way to get good yield without taking on big risks.
REIT Trades to Make Now
Among individual REITs I like are HCP (HCP), which I called out at the end of October, and Ventas (VTR). Both have low betas and high dividends — a beta of 0.12 for both, a yield of 4.9% for HCP and a yield of 4.2% for VTR.
If you want diversification, however, the Vanguard REIT ETF (VNQ) is a good option. It has a number of healthcare-focused plays as its top components — including HCP and Ventas right near the top of the list.
Overall its about 13% weighted towards healthcare, and is a great diversified REIT play.
Read more on the official Vanguard REIT ETF website for details.
High-Yield Investments — Preferred Stock
Remember when Bank of America (BAC) was cratering and paying a measly penny-per-share dividend, but Warren Buffett and Berkshire Hathaway (BRK.B) rode in to buy a boatload of preferred stock with a 6% yield?
The scale — and shrewd timing — of that deal was classic Buffett. But the fact that these preferred shares yielded a great dividend even as common shares paid squat is a powerful illustration of the “preferred” status of preferred stock.
Preferred stock is halfway between a bond and a stock. Preferreds have the low volatility and income focus of bonds, however they are frequently perpetual and without a fixed duration. Also, while preferred stockholders get a little preference in the event of bankruptcy, but still come after bondholders and debt obligations.
Anyway, the hybrid nature of preferred stock allows it to avoid some of the interest rate risk that long-term government and corporate bonds will suffer in the next year or so.
Preferred Stock Trades to Make Now
One of the big guys in the space is the iShares U.S. Preferred Stock ETF (PFF), with $10.5 billion in assets and a seven-year track record. And full disclosure: I personally own this ETF myself.
Other preferred funds may offer bigger yields but have only popped up a few years ago. PFF offers a 30-day yield of 5.7% currently — and is actually up about 8% in 2014 to boot.
I don’t expect outperformance given the sleepy nature of preferreds, but share appreciation is certainly a nice sweetener in addition to the juicy dividend.
Of course, it’s worth noting that many preferred funds are heavy into financials. If you don’t like this bent, the Market Vectors Preferred Securities ex-Financials (PFXF) is a unique option. It actually yields a bit more at nearly 6% yield right now so you won’t be sacrificing income for that pivot in strategy.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. As of this writing, he held a long position in PFF but no other securities mentioned here. Write him at firstname.lastname@example.org or follow him on Twitter via @JeffReevesIP.