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Wednesday, May 8, 2013 - 13:00
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Wednesday, May 8, 2013 - 13:00
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Wednesday, May 8, 2013 - 13:00

My 3 Favorite High-Yield ETFs For The Long Haul

Wednesday, May 8, 2013 - 1:00pm

Here at StreetAuthority, we talk a lot about the appeal of rising dividends, but it's unwise to pursue high yields solely through stocks. The market can gyrate wildly, and a bad quarter for any given stock can wipe out a year's worth of dividend payments.

As I noted in a recent look at Federal Reserve policy, fixed-income investors must continue to look beyond the traditional offerings from the U.S. government (bonds, bills, etc.) and banks (CDs) and seek out other investments that offer up more solid income payments.

That's why you need to keep tracking opportunities among bonds as well. Where some investors seek out the safety (and comparatively low yields) of investment-grade corporate bonds, and others prefer riskier but higher-yielding junk bonds, there is a middle ground.

Fixed-income exchange-traded funds (ETFs) offer decent yields and are comparatively safe because they own a basket of bonds, making them less vulnerable to a default by any one particular issue.

Another benefit of ETFs: There are now so many of them that you can choose from a wide range of options when building out your portfolio.

Here are three fixed-income ETFs that hold great long-term appeal.

1. PowerShares Senior Loan Portfolio ETF (NYSE: BKLN)
These days, even junk bonds (also known as high-yield bonds) have become quite popular with risk-averse investors. As a result, their rising prices have pushed junk bond yields down into the 5% to 6% range. Yet these bonds carry considerable risk. If any particular bond issuer defaults, only 44% of the assets end up being recovered, according to Morningstar.

That makes this ETF comparatively more appealing: Because it holds senior secured debt of these high-yielders, it will suffer less if there are defaults. Roughly 65% of assets secured by senior debt are recovered in bankruptcy proceedings.

And investors can still get solid yields. This ETF distributed $1.20 a share in 2012 and is on pace to maintain that payout this year, equating to a 4.8% yield.

An added benefit: The bonds in this portfolio are "floating rate," which means their payouts would rise in tandem with eventually rising interest rates. That means the value of the bonds will also remain constant as rates rise, unlike many bonds that lose value as rates move higher.

2. Vanguard Long-Term Corp Bond Index ETF (Nasdaq: VCLT)
If you are an active ETF investor, then you should always see what Vanguard has to offer. Vanguard focuses on low transaction costs, so the expense ratios among the ETFs are often the lowest in the segment. Just as important, Vanguard's risk-averse corporate culture means that the holdings in any portfolio have been vetted to ensure they aren't too risky.

And that sums up the appeal of this ETF. It has an expense ratio of just 0.12% and typically pays out roughly $4 a share in dividends every year, good for a 4.5% yield. The striking aspect of that yield is that this fund focuses on investment-grade bonds (rated BBB or higher) issued by companies such as General Electric (NYSE: GE) and Wal-Mart (NYSE: WMT). Many investment-grade bonds issued in recent quarters carry interest rates closer to 3%.

3. SPDR Barclays Capital Emerging Markets Local Bond ETF (NYSE: EBND)
When investors think about emerging markets, they think about volatile economies that can create havoc for leading regional companies. Yet there's no reason to take on corporate risk in these markets when government bonds, which are far less likely to default, already offer solid yields.

This ETF is loaded with government bonds from Mexico, South Korea, Brazil, Poland and elsewhere. The average bond sports a 4.5% yield. Compare that with U.S. government bonds, which typically yield less than 2%.

Note that this ETF owns these bonds in the local currency, so an upward move in the U.S dollar would eat into gains (conversely, a drop in the dollar would aid this fund's returns). Still, the currency risk is something you should always look into when seeking international exposure.

Risks to Consider: Bonds aren't risk-free, just much less risky than stocks. But they can fall in value in an era of slowing economic growth or rising interest rates.

Action to Take --> These funds don't offer the best yields around. Instead, they offer respectable yields while taking on less risk than junk bonds. Each of these three ETFs offers a different approach to this niche, and they can be owned as a group.

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David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.

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