3 Income-Oriented ETFs That Will Hold If Rates Creep Higher

Includes: BKLN, BSJI, MLPI
by: Gary Gordon

An overwhelming majority of commentators seem convinced that interest rates will remain elevated. Some have suggested that 2.72% on a 10-year yield is merely a pit stop on the way to a year-end close of 3.25%. I myself believe that global economic uncertainty coupled with disappointing corporate guidance will push the 10-year back down to 2.25% by year’s end. For that matter, I believe the Fed will wait to slow their bond buying program until 2014.

At the moment, I appear to be in the minority. Still, there are a great many individuals who require an income stream from their investments, whether rates fall, settle in at their current levels or creep higher. For that reason, I think it is important to identify income-oriented ETFs that are less sensitive to spikes or long-term changes in Treasury bond yields.

The first income-oriented possibility is PowerShares Senior Bank Loan (NYSEARCA:BKLN). In the bond swoon that has seen 10-years rise 100 basis points, BKLN has only forfeited 1.6% in price appreciation. The iShares 7-10 Year Tresury Bond ETF (NYSEARCA:IEF) is down 7.5%. While losing 1.6% on price may not be desirable, one is picking up roughly 4.4% in annualized income. In fact, if you haven’t purchased BKLN yet, even if the 10-year rose to 3.25% by year’s end, the annualized income of the remaining months in the year could still wind up generating 1.5% in income over the 6 months. If the 10-year holds flat, one might expect 2.2% in the 6 months. If the 10-year reverts to 2.25% as I suspect, BKLN would likely garner 3% in total return over a half-year, which is similar to the 6% annualized that many income seekers pursue.

Senior bank loans are floating-rate securities from below-investment grade companies. Unlike “junk bonds,” these debs have seniority over other creditors and the debts have been secured by collateral (e.g., real estate, etc.). Better yet, since the debt “floats” over short time periods, prices and yields can rise alongside interest rates. What makes BKLN particularly attractive include distributions that occur monthly as well as diversification across 135 holdings.

The second income-oriented ETF is actually an exchange-traded note (NYSE:ETN), UBS E-TRACS Alerian MLP (NYSEARCA:MLPI). While it is widely assumed that energy pipeline partnerships are interest rate sensitive (and in truth, they often are), there are plenty of instances when these high-yielders have stood their ground. For example, the folks at Credit Suisse pointed out that when rates had been rising and the Fed had been tightening between mid-2004 and mid-2007, MLPs managed to outperform aggregate bond indexes as well as the S&P 500. Similarly, over the last 2 months of rapidly rising interest rates, Vanguard Total Bond Market (NYSEARCA:BND) logged -3.6% while the S&P 500 SPDR Trust (NYSEARCA:SPY) registered 1.2%. Yet MLPI picked up 1.8%.

In truth, domestic demand for natural gas as well as other products pushed through pipelines in the U.S. is growing. It follows that the dividends that pipeline partnerships have to pay out can go up over time; price appreciation does not necessarily kill a reliable yield. And while there may be a variety of Alerian pipeline partnership ETFs and ETNs to choose from, the one with the best relative strength today is UBS E-TRACS Alerian MLP (MLPI).

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A third income-oriented ETF with potential in the current environment is Guggenheim BulletShares 2018 High Yield Corporate (NYSEARCA:BSJI). While short-term high yield may be a popular way to deal with rising rates, many worry about fund premiums and discounts in volatile markets. Perhaps the best solution for an ETF enthusiast is a fund that is diversified AND has an actual maturity date. Guggenheim BulletShares 2018 High Yield Corporate (BSJI) may be situated on the tail end of the 0-5 year horizon, but investors that purchased BSJI have less desire to trade than other ETF investors; they want to hold to maturity and this exchange-traded tracker should succeed in representing a held-to-maturity portfolio (100+ securities) with effective maturities in 2018.

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Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.