[This article appears in our October 2017 issue of ETF Report.]
Generating income is an ongoing challenge for investors everywhere, whether it’s someone nearing or at retirement, or someone simply looking to extract consistent income from their asset allocation.
ETF strategists and asset managers are faced with compressed bond yields—at 2.13%, 10-year Treasury yields are hovering near their lowest levels since mid-June. They know the challenge well, as they work with advisors and retail clients to meet income needs. Here, some of them offer their favorite income-generating ideas right now.
John Davi, founder & CIO, Astoria Portfolio Advisors, New York City:
The iShares U.S. Preferred Stock ETF (PFF) is my preferred income vehicle. It's a play on the enormous demand for income given global quantitative easing dropping bond yields to generational lows along with a bullish play on financials, banks in particular.
In the immediate period following the credit crisis, banks weren’t able to build net interest margins in a low-rate, flat-curve environment where there was little organic growth demand and muted inflation.
However, in an environment of higher growth with potentially less regulation, banks are well-positioned given their greater margin of safety compared to the broader U.S. equity market.
Banks make up 40% of PFF. As of July 31, the 12-month trailing yield was 5.6%, and 33% of the bonds are rated AAA.
At the time of writing, Astoria Portfolio Advisors owned positions in PFF. For a list of relevant disclosures, please click here.
Ben Lavine, CIO, 3D Asset Management, East Hartford, Connecticut:
The income question can be broken down into two components: fixed-income strategy and fixed-income portfolio.
Our favorite income strategy is time segmentation. That’s where an individual’s investment account is segmented into multiple “buckets” of, say, five years apiece, assuming a 20- to 30-year time horizon—a reasonable time horizon for retirees, given current longevity trends.
Each bucket would comprise its own asset allocation, with more conservative, guaranteed products comprising the current income segments up to 10 years, and traditional equity/fixed-income asset allocations comprising the later-dated segments. Time segmentation allows for both current income and growth of future income.
Now, our favorite income portfolio for, say, a five- to-10-year time horizon is to build a laddered bond portfolio with defined maturities using ETFs. The Guggenheim Bulletshares or the iShares iBonds ETFs provide investment-grade and high-yield bond portfolios with defined maturities, as opposed to traditional evergreen bond ETFs that never mature.
As the bond portfolios approach maturity, the portfolios become less sensitive to interest rate volatility, or the portfolio duration declines over time. Investors can then use the yield-to-worst (at entry) as an approximation of the rate of return, assuming the portfolios are held to maturity.
Investors can supplement this laddered bond ETF portfolio with higher-income-producing ETFs if they can stomach the market volatility associated with a reach for yield.
Our preference is to take credit risk in areas that have less equity market sensitivity, such as senior bank loans and variable-rate preferred securities. Our fixed-income ETF portfolios currently hold the First Trust Senior Loan Fund (FTSL) and the PowerShares Variable Rate Preferred Portfolio (VRP) for exposures to those areas.
[Here’s how FTSL and VRP are performing year-to-date]: