Two weeks ago, when Ben Bernanke and the Fed mentioned the word tapering in reference to the latest round of quantitative easing, it led to a massive wave of selling in the income ETFs.
The selling hit all asset classes from government bonds to corporate bonds to equities that pay above-average dividends. The thought of higher interest rates in the near future spooked investors enough to sell first and ask questions later.
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Typically, dramatic moves in the market with the income ETFs are driven by human emotions and they end up not being short-term pullbacks. Another common theme is that even quality ETFs will be pressured lower as the selling brings down the entire asset class. This mass selling opens up opportunities for investors willing to go against the crowd.
Within the carnage of income ETFs, there a handful that are now opportunities for longer-term investors searching for above average income.
Three diverse such ETFs are listed below.
The Alerian MLP ETF (NYSE:AMLP) is a basket of 23 master limited partnerships (MLPs) that concentrate on the processing, storage and transportation of natural resources. Of the three ETFs, AMLP has been able to hold up the best and is currently trading one percent off a multi-year high.
The ETF has already recouped almost all of the losses from late June, but due to its exposure to the energy sector and the 5.9 percent dividend yield, it remains an attractive investment opportunity for income investors. The annual expense ratio before deferred taxes is 0.85 percent.
The ProShares High Yield-Interest Rate Hedged ETF (NYSE: HYHG) offers investors exposure to high yield corporate bonds with a built in hedge against rising interest rates. Interest rates and bond prices have an inverse relationship, therefore a rise in interest rates will push down the price of bonds. HYHG attempts to mitigate that risk by taking short positions in US treasury bonds.
With high yield corporate bonds investors will receive above average income payments and if interest rates continue to rise, the short position in treasuries will lessen any selling in the corporate bonds. This ETF is in a sweet spot because high yield corporate bonds will likely continue to outperform treasury bonds and the hedging aspect should keep the volatility lower than its peers. The current yield is 5.7 percent and the annual expense ratio is 0.50 percent.
Municipal bonds have not been sheltered from the selling and the Market Vectors High Yield Municipal Bond Index ETF (NYSE:HYD) suffered one of its worst months in June. The ETF is composed of 75 percent below investment grade municipal bonds and 25 percent investment grade. The exposure to junk municipal bonds gives the ETF a yield of 5.3 percent, well above its competitors that only invest in investment grade bonds.
Because the income paid on municipals is federally tax-exempt the tax-equivalent yield for investors in the highest tax bracket (39.6 percent) is an eye-popping 8.8 percent. The ETF has found its footing in the last two weeks, but still trades 10 percent off its May high. The annual expense ratio is 0.35 percent
The three income ETFs are very different and each offers a unique approach to generating income in the current environment. Diversity is key to lowering risk even when focusing on only income ETFs.
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