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High yields are great, but only if they are safe. Here are three ETFs that provide that safety.
I cannot think of a better stock market innovation than the exchange-traded fund.
Until ETFs were created, the only way you could get a truly diversified basket of stocks was to use mutual funds. But mutual funds have their flaws, including much higher fees and restrictions than ETFs.
ETFs, on the other hand, are usually highly liquid, trade instantaneously like stocks, and there are almost as many varieties as there are species on planet Earth. They are also really cheap to own.
With that in mind, I went hunting for three ETFs that had really high yields, but that also had a relative degree of safety attached to them. That’s the other benefit of ETFs – namely, that they are high-yield investments that offer plenty of diversity.
I really like the US Equity High Volatility Put Write ETF (NYSE: HVPW). It uses an options strategy that I often use myself – selling puts against stocks that have high volatility, and therefore offer high premiums.
It sells 60-day put options every other month on 20 stocks that offer these high premiums, then distributes 1.5% of the fund’s net assets every 60 days. That money comes from the put option premiums and any capital gains it generates. HVPW doesn’t just grab any premium, though. It has a specific methodology. So far, that equates to a 9.3% yield.
The strike price of each put option must be as close as possible to 85% of the closing price of the option’s underlying stock price at the beginning of each 60-day period.
The downside is that HVPW gets stocks put to it that are horrible investments. Judging from its current list, however, none of these companies is in terrible shape.
Another favorite ETF of mine, and one I actually own, is the iShares U.S. Preferred Stock ETF (NYSE: PFF). Preferred stocks are the unsung heroes of income investors. These are stock-bond hybrids. Preferred stock is issued when a company wants to raise money without diluting existing shares.
They tend to pay high dividends and also tend to be very secure investments. Like bonds, preferred stocks trade in a very tight range. They are also just behind bonds as far as recovering your investment should a company go bankrupt.
PFF’s diversity is very attractive, with the top 10 holdings only taking up 12% of the total asset base. Those assets include all the big names that issue preferred stock, such as Citigroup (NYSE: C) and Wells Fargo (NYSE: WFC). The yield is a healthy 6.9%.
My last ETF choice is UBS ETRACS Wells Fargo Business Development Company ETN (NYSE: BDCS). As the name suggests, BDCS is a group of stocks for Business Development Companies.
BDCs invest in middle-market companies that are growing quickly but have already gotten the cheaper bank financing they could afford – or that they couldn’t afford and need to go to the secondary market.
The BDCs generally make senior loans and take small equity positions. They make their money primarily by borrowing at low rates from banks and lending to these middle-market companies at rates of 11-14%.
The safety here comes partly from the diversification of the ETF itself, partly from the BDCs that invest in dozens of companies. Therefore, the likelihood of catastrophic failure is low. The risk is that borrowing costs rise for BDCs – something doesn’t seem likely in the near future with rates so low.
Because business development companies must distribute 90% of their net income, BDCS’ the current yield is a very generous 7.8%.
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