1100 13th Street, NW, Suite 750Washington, DC 20005202.887.6400Customer Service: 800.544.0155
All Contents © 2019The Kiplinger Washington Editors
By Michael Foster, Contributing Writer
| May 30, 2018
If 2017 was the year without fear, 2018 feels like the year of … well, fear. And that means investors should have income funds and other dividend strategies at the top of their minds right now.
The CBOE Volatility Index – aka “the VIX,” aka “the fear index” – exploded earlier this year from less than 10 to more than 37. That occurred about a month into 2018 as the stock market fell to multimonth lows. The VIX spiked again in March and has remained elevated – at least compared to last year – since then. The market itself, meanwhile, is barely clinging on to fractional gains.
This has been a frustrating year for investors in search for direction. But those who have put income strategies to work likely have stomached the process with a little more ease. Don Wilson, CIO of Atlanta-based investment company Brightworth, says flat and down markets are a good time to put lower-risk, higher-quality income strategies to work. “In down markets, conservative, boring, higher quality and lower-yielding bonds usually hold up much better than higher yielding and lower quality investments,” he says.
Certain income funds not only provide dividends to help offset losses, but they prove particularly resilient during times of high volatility. A few were even able to hold their value during the selloff of early 2018.
Here’s a look at eight income funds that investors should explore if they’re looking to weather an uncertain 2018 while generating some extra cash.
Data is as of May 29, 2018. Yields represent the trailing 12-month yield, which is a standard measure for equity funds. Fund expenses provided by Morningstar.
Market value: $3.6 billion
Dividend yield: 2.2%
The iShares Core Dividend Growth ETF (DGRO, $34.28) invests in a bundle of stocks that have “a history of consistently growing dividends.” There’s not a terribly high bar for inclusion – DGRO looks for stocks with five consecutive years of dividend growth, versus 25 years to be included in the Dividend Aristocrats. Still, those histories of dividend growth help demonstrate financial stability, plus they mean that the current 2.2% yield on cost likely will improve over time.
Rick Wedell, CIO of hybrid RIA group RFG Advisory, says dividend-growth ETFs have “performed slightly better than the S&P 500 during the 2008 bear market” and during most corrections afterwards, which makes them worth consideration when the market is getting more risk-averse.
Dividend growth stocks are still stocks, of course, so you can expect some price declines if the market falls. “Note that dividend growth investing is still equity investing,” he says, adding that some mutual funds and ETFs focusing on rising dividend stocks “did not necessarily perform better than the broader market during 2008 or recent corrections.”
Still, investors can do well by investing in a blue-chip-heavy portfolio like DGRO’s, which includes the likes of Apple (AAPL), Microsoft (MSFT) and Pfizer (PFE), and charges a skinflint 0.08%, or $8 annually for every $10,000 invested, in fees.
Market value: $15.3 billion
Dividend yield: 2.4%
The SPDR S&P Dividend ETF (SDY, $91.81) is another fund that focuses on dividend growth stocks, but with an eye toward the longer-term. The SDY tracks the S&P High Yield Dividend Aristocrats Index – a collection of stocks within the S&P Composite 1500 that have improved their payout annually for at least two decades.
By valuing a longer history of dividend growth, the fund is more skewed toward older, more stable companies that have made income a high priority. However, that also weeds out some stocks that might be earlier in their dividend ramp, but also still well within their growth ramps.
Consumer staples (15%) and utilities (13%) are unsurprisingly high sector holdings, with financials (15%), industrials (13%) and consumer discretionary stocks (11%) also commanding large slices of the asset pie. That also nudges SDY more toward value picks than growth.
The top holdings, however, are dominated by real estate investment trusts (REITs) – a high-yield industry of companies that own and operate real estate. SDY’s largest holdings right now are Realty Income (O), National Retail Properties (NNN) and Tanger Factory Outlet Centers (SKT).
Market value: $9.2 billion
SEC yield: 2.4%
The iShares National Muni Bond ETF (MUB, $109.29) is a low-cost index fund that gives investors broad exposure to municipal bonds – debt issued by entities such as states, cities and counties – from across the country. These are a favorite of investors who want diversification and low volatility.
There’s another big appeal to MUB and other municipal-bond funds: The income is exempt from federal taxes, and even state and local taxes depending on where the bondholder lives. Even if you just factor in the federal tax break, that would mean you would need to earn a 3.8% yield on a regularly taxed ETF to earn the same amount of income you get from MUB’s 2.4%.
From a diversification standpoint, iShares’ muni-bond fund is heavily overweight in California (22%) and New York (21%) issues, with additional exposure in Texas (8%), Massachusetts (5%) and New Jersey (5%), among other states.
Municipal bonds, like all bonds, tend to be interest-rate-sensitive, which is a risk to understand as the Federal Reserve is expected to raise rates three or four times across 2018. However, MUB’s struggles so far this year seem to be already pricing in those anticipated rate hikes.
* SEC yield reflects the interest earned for the most recent 30-day period after deducting fund expenses. SEC yield is a standard measure for bond funds.
Market value: $364.2 million
Distribution rate: 4.3%
The AllianceBernstein National Muni Fund (AFB, $12.67) is similar to MUB in that it provides broad exposure to municipal bonds, but there’s a key difference: While MUB is a low-cost index ETF, AFB is an actively managed closed-end fund that charges the high prices associated with active management.
AFB’s fees of 1.78% are considerably higher than the iShares ETF’s expenses, but they might be worth it.
For one, you’re getting a much higher distribution of 4.3% thanks to leverage. While MUB simply invests its net assets in the muni market, AFB “borrows” roughly 40% of its NAV in the form of issued preferred stock and variable-rate loans, which it then uses to extend its exposure to muni bonds — thus providing more income for investors.
There are clear risks in using leverage, but AllianceBernstein’s managers have a good track record of managing those risks. Over the past 10 years, AFB has posted a 65% total return versus 44% for MUB.
* Distribution rate can be a combination of dividends, interest income, realized capital gains and return of capital, and is an annualized reflection of the most recent payout. Distribution rate is a standard measure for CEFs.
Market value: $7.0 billion
Dividend yield: 3.4%
The Utilities Select Sector SPDR Fund (XLU, $91.81) is, like the utility stocks it holds, a popular option among income investors. That’s because this sector typically offers a higher-than-average yield and steadily rising payouts. The fund’s payouts have actually improved by roughly 40% over the past decade, which has helped fuel a roughly 80% total return in that time.
The fund holds 28 utility stocks, so it’s a diversified roster of companies within the sector, though it is overweight the S&P 500’s largest utility companies. NextEra Energy (NEE), for instance, makes up 12% of the fund’s assets, while Duke Energy (DUK) is another 8%. Those are some heavily concentrated bets.
Investors shouldn’t expect massive growth spurts from XLU, as utility companies are highly regulated and can’t simply jack up the prices of electricity overnight. However, they can and do regularly ask for small increases over time, which helps fuel slow and steady growth in both share prices and dividends.
That’s why funds such as SPDR’s utility ETF tend to attract investors when riskier parts of the market are crashing.
Market value: $1.4 billion
Distribution rate: 7.2%
Think of the Reaves Utility Income Fund (UTG, $28.18) as XLU’s aggressive distant cousin. Like XLU, this is a utility fund, but it’s not indexed, it’s actively managed (hence the higher fees). But again, the income aspect is much more generous.
Higher income streams sometimes come at the risk of lower returns – managers invest in higher-risk bets that offer more yield, and when those bets don’t pay off, investors ultimately suffer. But that’s not the case with UTG, which has ripped off 144% in total returns since this point in 2008 – far better than the XLU.
UTG holds many of the same companies that XLU does, such as NextEra and Sempra Energy (SRE). However, it also holds utility-esque companies such as Verizon (VZ) and AT&T (T), which are technically telecoms – but you can make an argument that telecommunications services are a basic human need, just like energy, and that AT&T and Verizon operate with very little competition, just like utility stocks.
Market value: $2.6 billion
Dividend yield: 3.6%
The PowerShares S&P 500 High Dividend Low Volatility ETF (SPHD, $39.81) says it all in the name. This equity fund is focused on providing better-than-average dividends while also offering lower-than-average volatility. And while dividend growth isn’t necessarily a goal of this fund, it’s there in spades; the annual payout has spiked by 50% in just four years.
High-yield dividend stocks can be volatile because in some cases, a very high yield is an indication that the underlying company comes with a high amount of risk. However, SPHD attempts to tamp down this issue by also focusing on companies with low volatility. By focusing on companies with high dividends and relatively stable prices, this PowerShares ETF can offer good income and good performance with a less bumpy ride than standard dividend funds.
This dual mandate results in a portfolio that’s heaviest in utilities and REITs, each commanding 21% of the fund. Consumer staples (145) are another unsurprisingly high sector holding. At the moment, top individual weights go to a pair of REITs – HCP Inc. (HCP) and Iron Mountain (IRM) – as well as utility company FirstEnergy (FE).
SEC yield: 3.0%
U.S. Treasuries are a classic defensive play. After all, few bonds are considered safer than those issued by the U.S. government – so much so that investors often pile into them when the stock market looks shaky.
Thus, the iShares 20+ Year Treasury Bond ETF (TLT, $122.24) is in many ways an ideal fund for a scared market. While many investors fleeing to safety will sock money away in short-term Treasuries that aren’t as interest-rate sensitive, others still will chase the higher yields of longer-term bonds, such as those in the TLT. That’s why TLT soared during the Great Recession, and why Treasuries tend to go up in value during recessions historically.
This moment in time is a bit different than in the past. The Fed is raising interest rates (rather than sending them into the ground, like it did during the Great Recession). That poses a risk to long-term Treasuries, as bond prices fall as yields rise. Also, long-term Treasuries have reversed their negative correlation to stocks in recent months, meaning they’ve actually gone down alongside stocks – a historical anomaly.
However, growing geopolitical risk in various pockets of the world could help shake investors out of equities and back into bonds, reverting things to their historical norms. That would bode well for funds such as the TLT.