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All Contents © 2017The Kiplinger Washington Editors
By Daren Fonda, Senior Associate Editor
| February 2017
Rising bond yields make it easier for investors to pocket decent income these days. The yield of the benchmark 10-year Treasury bond has crept up from a low of 1.4% last July to 2.4%. Yields in other parts of the fixed-income market have increased, too.
Even so, high-grade bonds such as Treasuries may not make you much money. That’s because bond prices fall as interest rates increase. And if the bonds don’t yield much to start with, you could lose money overall. Over the past three months, as market rates have increased, the Bloomberg Barclays U.S. Aggregate Bond index has fallen by 0.5%, including interest payments. Treasuries and other high-quality bonds may still provide protection against a stock market downturn, helping your portfolio hold up. But with the economy looking healthy, rates are likely to keep inching up, pressuring bond prices along the way.
For more income—and better potential for positive total returns—consider stashing some of your portfolio in high-yield stocks and bonds. Some real estate investment trusts, especially those that own hotel properties, pay more than 6%, for instance. You can also find plump yields among energy master limited partnerships, closed-end funds (mutual funds that trade like stocks), high-yield “junk” bonds and shares of investment management firms.
Here are three stocks and three funds that yield 5% or more. Individually, these picks may be too spicy for conservative investors, and we don’t recommend them for the core of your portfolio. You can lower your risks by spreading your bets. And dipping in gradually over time is a good idea. In the event that high-yield stocks and bonds start heading south, you’ll wind up with a lower average cost, losing less than if you’d invested all at once.
All prices and other data are as of February 13. Click on ticker-symbol links in each slide for current prices and more.
Share price: $28.76
Market value: $60.5 billion
Dividend yield: 5.7%
Enterprise Products Partners owns pipelines, processing plants and other types of oil and gas industry infrastructure. It’s one of the largest energy master limited partnerships around. The firm’s 49,000 miles of pipelines connect to major U.S. production regions, export terminals along the Gulf Coast and refineries east of the Rockies. Thriving natural gas production, a rebound in oil drilling and exports of refined fuels are lifting Enterprise’s sales and profits. The firm is expanding, too, with plans to spend $6.7 billion on new pipelines and other projects over the next few years.
These projects should help Enterprise hike its shareholder distributions, which have risen for 50 consecutive quarters. Enterprise also maintains one of the sturdiest balance sheets in the industry, say analysts at Credit Suisse. The partnership’s finances include a big cushion of retained earnings, which may help the firm weather a downturn in energy prices and keep its distributions afloat.
The risk with Enterprise is that if oil and gas prices weaken, domestic production will fall. But prices seem to have stabilized in recent months and may continue to firm up if producers in the Middle East adhere to production limits. Global demand for energy looks healthy. And U.S. energy MLPs may benefit from an easing of industry regulations and subsequent uptick in domestic production.
Note that Enterprise’s distributions aren’t considered dividend income for tax purposes. Instead, they may be treated as a “return of capital” or business partnership income, complicating your tax filings. Consult a tax planner before investing.
Share price: $21.57
Total assets: $825 million
Dividend yield: 6.8%
An exchange-traded fund, Global X SuperDividend ETF owns 98 high-yielding stocks, emphasizing property-owning real estate investment trusts, mortgage REITs (which own mortgage debt) and energy MLPs. Many of these stocks yield well above 7%, led by high-paying mortgage REITs such as Annaly Capital Management (NLY) and mortgage-servicing company New Residential Investment (NRZ). The ETF also gets a yield boost from foreign stocks, including financial services firm Bendigo and Adelaide Bank in Australia and Veresen, a Canadian pipeline operator.
Investors face a few specific risks with this ETF. One is that it holds many small-company stocks, which tend to be less stable than large-caps and may fall precipitously during a market downturn. The fund’s heavy concentration of REITs—about half the portfolio—could be a drawback if real estate slumps. The fund poses some currency risks, too, due to its 49% stake in foreign stocks.
These issues can help drive an uneven performance: The fund lost 8.6% in 2015, including dividends, then rebounded by 13.3% in 2016. Still, the fund’s distributions should roll in reliably. Its 0.58% expense ratio isn’t cheap for an ETF, but it remains well below the fees charged by actively managed global stock funds.
Share price: $31.70
Market value: $5.2 billion
Dividend yield: 6.4%
One of the largest REITs focused on lodging, Hospitality Properties Trust has invested $9 billion in hotels around the country and in highway travel centers for truckers. Hotel operators such as Marriott and Hyatt run the lodging business, paying Hospitality a cut of their revenues from more than 46,300 rooms at its 305 properties. Those revenues bounce around with room and occupancy rates and hotels’ operating profits. Growth has decelerated in recent years as vacation rental sites such as Airbnb have cut into revenues for traditional hotels.
But the hotel business is far from dying. Hospitality has plowed more than $1 billion into renovating almost all of the properties it leases to hotel operators over the past five years, boosting their appeal. That’s in addition to what operators kick in toward refurbishment. Agreements with most of Hospitality’s hotel managers require fixed minimum rents per room, keeping a floor under the firm’s revenues. Moreover, Hospitality’s truck stop business is thriving. The company owns 198 Travel Centers of America—places where truckers stop to eat, rest and fuel up their rigs. Non-fuel revenues from the business have climbed at an average annual pace of 8.8% since 2011, increasing each year, says Hospitality.
Rental sites such as Airbnb do pose problems. But investors can still fare well with the stock, which has returned 52% in the past year, including dividends. The firm’s payout looks secure, and it should continue to increase as Hospitality buys more properties and gradually hikes rents.
Share price: $46.10
Market value: $7.2 billion
Dividend yield: 5.5%
Oaktree Capital is a Los Angeles-based investment company that manages about $100 billion, emphasizing “alternative” assets such as convertible securities, real estate loans and distressed debt (bonds or other types of debt trading at pennies on the dollar). Leading the firm is Howard Marks, a veteran investor in distressed debt who has built a stellar reputation as a value manager. Pension funds and other big, institutional investors pay Oaktree handsomely for the investment expertise of Marks and his team. Oaktree also runs bond funds, including Vanguard Convertible Securities, and the RiverNorth/Oaktree High Income fund, which it comanages with investment firm RiverNorth Capital Management.
A downturn in real estate may hurt Oaktree’s property values and fee income from managing funds. But it would also create opportunities for Oaktree to pick up more distressed debt. The firm’s profits have been depressed, in fact, because Marks and his team can’t find enough compelling opportunities for all the cash they have raised. The company is sitting on a near-record $20.8 billion in “dry powder” that it hopes to invest in distressed debt and other assets (and start earning management fees for).
Also appealing is Oaktree’s stake in DoubleLine Capital Management. Run by Jeffrey Gundlach, a superstar bond fund manager, DoubleLine’s business has surged in recent years, lifting the value of Oaktree’s 20% stake well above its cost, says Mark Travis, lead manager of the Intrepid Capital Fund, which owns Oaktree stock. That DoubleLine stake isn’t fully reflected in Oaktree’s book value (assets minus liabilities), says Travis. Based on his estimates of Oaktree’s book value, he figures the stock would be worth $60 to $65 a share to a private buyer of its assets.
One caveat: Oaktree is a limited partnership whose distributions typically include various types of dividend income, interest income and capital gains. Consult a tax planner before investing.
Share price: $5.23
Market value: $636 million
Dividend yield: 6.0%
Putnam Premier Income Trust is a closed-end fund that holds a blend of mortgage-backed securities, junk bonds and foreign debt, with 15% of the fund in emerging markets. The mix may look quite risky. But 53% of the fund consists of AAA-rated bonds—the highest grade from a credit-risk perspective. The high-quality debt should help support the fund’s share price if junk bonds or other risky types of debt lose value.
Another attractive aspect of the fund is its lack of sensitivity to interest rates. Manager William Kohli and his team use hedging techniques and interest-only mortgage bonds (which gain in value as rates increase) to offset the threat of higher rates. In fact, the fund has a negative duration, a measurement of interest-rate sensitivity, which means the overall portfolio would increase in value if market rates rise—the opposite of most bond funds. “You’re getting a yield above 5.5% in a fund that will go up in price if rates move higher,” says Kohli.
Granted, a steep drop in rates could drag down the fund’s share price. But with the economy gaining strength, rates are more likely to rise, especially as the Federal Reserve lifts its benchmark short-term rate in 2017, as we expect.
This fund is a closed-end version of Putnam Diversified Income Trust (PDVCX), a traditional mutual fund that holds a similar mix of bonds. But Premier Income looks like a better bet. It trades at a 6.4% discount to the net asset value of the fund’s holdings. That discount to the fund’s NAV helps push its yield above that of the mutual fund, which pays 4.7%. Unlike many closed-end funds, moreover, this one doesn’t use leverage (borrowed money) to juice its payout.
Share price: $29.46
Market value: $640 million
Dividend yield: 5.4%
Funds holding high-yield bonds had a stellar year in 2016, returning an average 13.3%. But Van Eck Vectors Fallen Angel High Yield Bond, a member of the Kiplinger ETF 20, sprinted ahead by 25.7%. This exchange-traded fund is beating the category average this year, too, inching ahead of its peers by 1.0 percentage point.
The fund’s winning formula: investing in “fallen angel” bonds. These are bonds that have lost their investment-grade ratings and now sit at the top of the junk ratings ladder. That still makes them risky in terms of the potential for issuers to default. But the bonds aren’t nearly as dicey as those on the bottom rungs of the ladder. Moreover, the bonds could get a bump in their credit ratings if their issuers’ business improves, potentially lifting them back into the investment-grade category. Bond prices would move higher as a result.
Some of the bonds in this ETF may strengthen in price even without a credit-rating upgrade. About half of the fund sits in debt issued by producers of crude oil and other raw materials, such as copper and silver. These companies are getting a lift from stronger energy prices and a firming economy, and their bonds have increased in price as investors bet that issuers will be less likely to default. If that proves to be the case, the ETF should continue to rally, with price gains helping to produce total returns that could easily top the fund’s current yield.
One threat to this ETF would be rising interest rates. The fund’s average duration—a measure of interest rate risk—is 5.8 years. That means its share price could decline by 5.8 percentage points if market rates increase by a point, wiping out more than a year’s worth of interest. Still, the fund has held up throughout the recent bout of rising rates—climbing by 7.9% in the past three months. A collapse in raw-material prices or a recession on the horizon would hurt the fund, too, though neither of those threats look imminent.
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