Tags: Income | etf | exchnage | funds

Best of Both Worlds: Income-Producing ETFs in Review

Wednesday, 23 May 2012 03:44 PM

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The simple idea of owning an exchange-traded fund (ETF) is buying exposure on the cheap, usually to equities. That is, rather than concentrating your risk on 10 or even 100 stocks, why not buy equal but tiny slices of 500 or 1,000 and get a tiny management fee to go along with it?

In a long-term bull market, there’s a lot to like about this logic. You can buy on a dip and hold for years and years with no significant tax concerns until you sell it off. If the overall market performs, you get that performance at an absolutely minimum cost and with a minimal tax burden. Investing nirvana.

Even if you buy and sell periodically to rebalance, ETFs can be a powerful tool.

Editor's Note:
Obama Donor Banned This Video But You Can Watch it Here


Unlike index funds, you can buy ETFs that concentrate on narrower asset classes, such as emerging markets or commodities, while enjoying the liquidity and tax advantages of fund investing.

All this goes out the window, however, if you need income. Sure, the S&P 500 pays a yield, but it’s currently just above 2 percent. Subtract fund costs and you end up about in the same neighborhood as 10-year Treasurys but with significantly higher risk. These are stock investments, after all.

One tactic, then, is to concentrate your risk by buying five or 10 high-yield dividend stocks, then hope that the dividends are not cut. Another, however, is to buy into one of several ETFs set up to offer solid income while providing the broader, less-volatile exposure of a fund.

John Prestbo, editor and executive director of Dow Jones Indexes, recently identified three potential candidates. They are:

1. iShares Morningstar Multi-Asset Income Index Fund (IYLD)

2. SPDR SSgA Income Allocation ETF (INKM)

3. Arrow Dow Jones Global Yield ETF (GYLD)

Their differences are significant, as Prestbo points out. The first two invest in other ETFs, while the Arrow fund buys assets directly. The yields vary (and the Arrow fund he estimates by backtesting an underlying index), but they beat the pants off of stocks in general, at least in terms of yield, ranging from above 5 percent to above 7 percent. Fees are all well below 1 percent.

“What to make of all this? If you are really interested in investment income, these ETFs are worth some tire-kicking,” Prestbo says. “They combine arrays of income-producing asset classes for you, thus simplifying portfolio administration considerably. However, you must be comfortable with the types of investments being combined.”

For instance, the funds can hold investments in master limited partnerships. They also buy into royalty trusts, corporate bonds, preferred shares and sovereigns.

Prestbo’s caveat is well taken. You might be duplicated positions elsewhere or increasing your risk in ways that are difficult to measure. If you can understand and handle the risk, however, income ETFs might be the solution.

Editor's Note: Obama Donor Banned This Video But You Can Watch it Here



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