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It’s the worst of times, it’s the best of times. I say that in regards to dividend investing, and with due apologies to Charles Dickens for mangling his famous “A Tale of Two Cities” introduction.
To be honest, it may not be the worst of times, but for many income investors it’s been bad. Many traditional high-yield dividend sources have taken a hit: specifically, REITs, MLPs (technically they pay distributions, not dividends) and utilities. The KBW Premium Yield Equity REIT ETF (NYSEArca: KBWY) is down 10% year-to-date, the Alerian MLP Fund (NYSEArca: AMLP) is down 16%, and the Utilities Select Sector SPDR Fund (NYSEArca: XLU) is down 5%.
You’ll notice a correlation between yield and selloff with these investments: The higher the yield, the greater the selloff. The AMLP fund offers the highest yield, at 8.1%. The KBWY yields 5.3%; the XLU yields 3.4%. Investors appear more yield satiated than yield hungry.
These investments share a common denominator: They are all treated as fixed-income surrogates. They’re valued for their income stream as much as anything.
This means there is a common concern that weighs on each of these investments – interest rates. When interest rates are expected to rise, the value of fixed-income investments fall. We see this relationship in bond prices all the time. Because there isn’t a lot of income to be gained from high-grade bonds, many investors look to the aforementioned investment classes for income. All three are trading at a discount because of the impending threat of rising interest rates.
For most of 2015, the Fed has left investors hanging. At the beginning of the year, most everyone was gunning for June for the first rate hike. After June came and went, September became the designated month. Now it appears September has been shelved and December is the new target. Continued uncertainty has unsettled many high-yield income investors.
I have a different view. I see today’s discounted prices in REITs, MLPs and utilities as an opportunity to pick up even more yield.
For one, when and if the Fed moves to raise interest rates, it will do so in baby steps. I see no more than a 25-basis-point increase in the federal funds rate (the overnight lending rate among commercial banks). This is the rate commentators refer to when they comment on the Fed raising interest rates.
That said, it might not matter anyway. Commercial REITs have typically done well when interest rates rise. They’ve generated an average annual return of 11.4% over the six monetary tightening cycles that have occurred since 1979.
MLPs also tend to do better than most investors expect. The past 10 times the yield on the 10-year U.S. Treasury note rose a full percentage point or more, MLPs rose nearly 5%.
Utilities tend to be more interest-rate sensitive, but they can still perform. During the last rise in interest rates that occurred in 2013, most managed to hold their own. The XLU even finished the year up a couple points. (The difference between then and now, though, is that the rate increase was market driven, not Fed driven.)
Of course, there are other variables involved. MLPs are heavily concentrated on energy, and energy prices have been trending lower for the past year. That’s a concern. Many REITs and utilities carry a heavy debt load. Refinancing during a period of rising interest rates could hurt cash flow, and possibly payouts.
That said, I see a lot of high-yield value that’s worth buying. At High Yield Wealth, we recommend a couple REITs with yields of 9% that have proven they have no trouble maintaining their dividend payout, regardless of where we are in the interest-rate cycle. We even have an energy MLP that yields 8.8%, which has increased its payout every quarter for the past eight quarters. The most recent increase occurred only last week. Energy is supposed to be dead in the water.
It might not be the best of times for high-yield investors, but it is a good time to pick up safe, high-yield dividend investments if you are a contrarian high-yield investor.