Great rates in a low-yield world
BY Jeffrey R. Kosnett, Kiplinger's Personal Finance — 06/01/10
You're earning zilch on your savings. No sweat. We offer 18 investments that pay 5% or more.
A year ago you needed the nerves of a tightrope walker to buy any income security that didn't include the word Treasury in its name. Prices for just about everything else -- including corporate debt, real estate trusts and preferred stocks -- had been so pummeled that you could have been excused for thinking America was going out of business.
But, as we now know, this was a spectacular buying opportunity. Once credit markets thawed and investors gained confidence that a depression had been averted, just about every yield-oriented investment outside the comfort zone of Treasury bonds staged a rally for the ages. Over the past year, for example, junk-bond funds have gained nearly 50% on average, and the typical real estate fund has returned nearly 100%. Some preferred stocks of troubled banks have quintupled.
As a result of this remarkable rebound, high-income stocks, bonds and funds are no longer steals. But many still pay far more than the bupkis you get from money-market funds, and they outyield Treasury bonds, too. Plus, today you can buy high-yielding securities without assuming especially large risks. Continuation of a slow economic recovery should boost the fortunes of corporations and state and local governments without pushing up inflation, which would lead to higher interest rates in the bond markets -- and lower prices for many kinds of fixed-income securities (bond prices and interest rates move in opposite directions). Below, we list 18 investments that yield 5% or more, in ascending order of risk.
Taxable munis
In little more than a year, cities, states and public agencies have issued $100 billion of taxable Build America Bonds. BABs pay extraordinarily high interest rates because Uncle Sam, as part of the 2009 financial-rescue package, picks up 35% of the issuers' interest costs. BABs now yield more than corporate bonds with like maturities and credit ratings, making them great not just for IRAs and other tax-deferred accounts, but for taxable accounts as well.
Yields of at least 6% are common for new, long-term BABs. The state of Illinois, for example, just issued 25-year BABs at 6.6%. These are general-obligation bonds, backed by the state's taxing power. Standard & Poor's rates Illinois A-plus, although the state is on watch for a possible rating downgrade. If you prefer to lend to an entity that appears to be in better shape, consider a new, 30-year New York City water-and-sewer revenue bond. The BAB, rated double-A-plus, hit the market at 6.4%.
Fans of exchange-traded funds should consider PowerShares Build America Bond ETF (BAB , $25). With an average credit quality of double-A, it pays dividends once a month and yields 6.2% (all prices and yields are as of the April 9 close).
Preferred stocks
A preferred stock is closer in spirit to a bond than a common stock because a preferred dividend is almost always fixed. So if long-term interest rates rise, a preferred reacts like a bond and loses value. You also face company risk should the issuer run into trouble and suspend preferred dividends. If you can stand some price fluctuation, consider reinsurer Endurance Specialty Holdings 7.75% Preferred (ENH/PA , $24). Rated triple-B-minus, the issue is not callable until 2015 and sports a current yield of 8.1%. Under current federal law, the top tax rate on qualified dividends is just 15%. (Many stocks that look like preferreds are actually hybrid securities and aren't eligible for preferential tax treatment.)
Banks, insurers and real estate investment trusts are the most common issuers of preferreds. With a preferred-stock ETF, you can diversify into utilities and industrials. The oldest and largest among these is iShares U.S. Preferred Stock Index ETF (PFF , $39). It pays dividends monthly and yields 6.5%.
Juicy dividend payers
The overall U.S. stock market yields less than 2%, but you'll find plenty of profitable, blue-chip outfits that pay far more and are willing to maintain and even raise their disbursements. The best sources of fat dividends are utility, energy, drug and consumer-products companies. Should the economy start to weaken again, at least three of those sectors -- energy being the exception -- should hold up relatively well.
Shares of two telecommunications giants offer exceptionally generous yields. AT&T (T , $26) and Verizon (VZ , $30) recently yielded 6.4% and 6.3%, respectively. Although drug makers remain extremely profitable and have continued to pass out gobs of cash, their share prices have been stagnant for years, resulting in high yields. Our favorite for dividends: Eli Lilly (LLY , $37). Lilly has boosted its distribution 28 straight years, yet still pays out only half of its earnings. Its stock yields 5.3%.
Traded partnerships
Master limited partnerships are limited partnerships that trade on exchanges like stocks. MLPs pay no corporate taxes, so they can pay ample income to investors. On the downside, MLPs can add extra work when you prepare your taxes. Our favorite MLPs are those that own pipelines and energy terminals. They earn predictable fees and rents, rather than depend on the price of raw materials and refined fuels. Historically, these kinds of MLPs have yielded three to four percentage points more than Treasury bonds. That means they should yield 7% or higher today.
If you screen for MLPs that carry less debt than their peers yet still offer superior yields, two that stand out are Boardwalk Pipeline Partners (BWP , $30), which yields 6.7%, and Copano Energy (CPNO , $26), which yields 8.9%. Boardwalk owns three pipelines and 11 underground natural-gas storage fields; Copano operates gathering and transmission pipelines for gas producers in Louisiana, Oklahoma, Texas and the Rocky Mountains. An alternative to individual MLPs is Kayne Anderson MLP (KYN , $27), a closed-end fund that uses leverage (borrowed money) and has investments in 45 pipeline and storage MLPs (closed-end funds trade like stocks). Kayne Anderson recently yielded 7.1%, even though the shares traded at a 10% premium to the fund's net asset value. If you can buy the fund at a smaller premium -- or better yet, a discount -- pounce.
Treats With REITs
Beyond the fact that they were dirt-cheap near the end of the financial crisis, it's hard to explain why real estate investment trusts have performed so spectacularly. Most REITs own properties, such as office buildings, shopping centers, warehouses and posh mixed-use developments, that are hungry for buyers and tenants. Rents in many categories are flat or falling. REITs carry a lot of debt.
Still, you can find a few outliers that yield at least 5% and are reasonably safe. REITs that own health-care properties come to mind. Unlike offices and hotels, which are closely tied to the overall health of the economy, medical property is a growth business. And REITs own only 6% of U.S. health-related property, while they own 12% of all commercial real estate. So as health care assumes a greater share of the economy, medical REITs will have plenty of opportunities to build and buy. One of the best REITs in this sector is Health Care REIT (HCN , $46), which owns a wide range of facilities, including hospitals, nursing homes and medical-office buildings. It yields 6.0%. Another good choice is LTC Properties (LTC ), a much smaller REIT that owns nursing homes and assisted-living facilities in some 30 states and yields 5.5%.
Outside of health care, consider Realty Income (O ), a retail-property REIT that signs tenants to triple-net leases. These require clients to pay for property taxes, insurance and maintenance as well as rent. Realty Income has high occupancy and low debt, and it has paid monthly dividends for 40 years. It yields 5.4%.
One of a kind
Although it's set up as a REIT, Annaly (NLY , $17) owns no property. Rather, it borrows at short-term rates and invests the proceeds in medium- to long-term government-guaranteed mortgage securities. As long as the Federal Reserve holds short-term rates near 0% (1% would be okay), Annaly earns a bundle. And because it's a REIT, it must pay out at least 90% of its net income to shareholders. Over the past four quarters, it has paid $2.69 a share, which works out to a yield of 15.6% at the current stock price.
Normally a yield that high is a warning to stay away. But because Annaly's portfolio contains only government-backed securities, you needn't fear a rash of loan defaults. "This isn't glamorous or sexy," says Greg Merrill, a Seattle investment manager and a big fan of Annaly. "In fact, it's boring." Nothing wrong with that.
High-yield closed-ends
This category requires caution. Some high-paying closed-end funds aren't actually earning the amount they pay out (you can glean this sort of information from fund shareholder reports). Take a pass on those. However, others cover their high distributions with real earnings and income. If you invest at or below net asset value -- a wise idea when buying any closed-end -- you get good income at a fair price.
MFS Special Value Trust (MFV , $7) invests in an unusual combination: junk bonds and high-yielding stocks. It doesn't use leverage to enhance returns, but that doesn't mean it's a low-risk fund. It lost 35% on assets in 2008 and then gained 58% in 2009 (because investors become more enthusiastic about closed-ends in up markets and tend to unload them in down markets, the swings in performance based on share price were even more dramatic). The fund pays dividends every month from capital gains and interest income. It recently traded within a few cents of its NAV and is on track to distribute 69 cents a share this year. At the current price, that puts the yield at 9.5%.
Strategic Global Income (SGL , $11) has what's known as a managed-distribution policy. The fund, which doesn't use leverage, pays out 7% of NAV each month, using interest income and capital gains to cover the distributions. It's a go-anywhere bond fund, so the managers explore all sorts of investments, but their record has been decent over the past few years. The fund lost a modest 11% during the 2008 disaster, then staged a powerful 40% advance in 2009. The shares trade at a 10% discount to NAV, which explains why they yield 7.8% -- more than the distribution rate.
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All Contents © 2010 The Kiplinger Washington Editors
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