Be Wary Of Selling Out For Yield At Any Cost

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 |  Includes: BIP, PCY, STO
by: Roger Nusbaum

The other day I read yet another article about how to capture yield in this environment of zero percent rates. We've not made any radical changes to what we've been doing fixed income wise in the last few years as US rates have been low and generally gotten lower and the visibility for them to remain low for quite a while is pretty clear. I have not changed my belief that the US' fundamentals argue for higher rates but market prices diverge from fundamentals all the time.

A common case being made these days is that investors should buy dividend stocks instead of bonds. If you want do that just realize that dividend stocks are stocks not bonds and have volatility characteristic of stocks not bonds because they are stocks. There is a reason why most people have some sort of mix of stocks and bonds; they tend to react and behave differently. The manner in which a dividend stock may react to various factors might be relatively muted compared to the broad market but they are merely different shades of the same color.

To the extent people need income from their portfolios (so not talking about the accumulation phase people) one suggestion is to add some yield to the equity portion of their portfolio. This is not a call to change the asset mix but to increase the yield of one portion. This can be done several ways but I will say I think it is easier by using individual stocks instead of funds.

So with the energy sector an equal-weight allocation is low double digits. That is enough to take in something like Statoil (NYSE:STO) which we have owned for years and usually pays 4-5% in dividends or some other big cap foreign stock with a similar yield. There is also room to take in an MLP or two and those yields range from 5-9%. Something yielding 5% will probably be less volatile than a 9% yielder so maybe one of each MLP (that being one 5%er and one 9%er). There would still be room for something that was more growth oriented which might come from some theme with good prospects. This mix obviously tilts to yield but is not exclusively yield oriented.

With the tech allocation, someone needing more yield might have luck with a semiconductor stock. There are a lot of them that yield above 3% with quite a few near 4%. Financial stocks typically have decent yields but I would suggest looking at banks outside the US, Big Western Europe, Japan and China. There are some relatively healthy smaller US banks with good yields but this is difficult work.

There are also higher yielding products that should be treated like equities to consider. We owned one a few years ago, MIC, and it got crushed in the crisis. That it got crushed was not a big deal because our exposure was so limited. Something like Brookfield Infrastructure (NYSE:BIP) could work but I would expect it and anything like it to get crushed should there be some sort of 2008 repeat. Own one of these in moderation, then it is just an inconvenience like MIC in 2008, own a bunch and it becomes a problem in a 2008 repeat.

As for actual fixed income, yields are low. If the yield of an entire fixed income portfolio is not low right now then there is risk being taken. That is only bad if the end user doesn't know that risk is being taken. A large portion of what we own are short dated, high quality domestic corporate debt and the yields are very low but better than Treasuries. We are not taking meaningful interest rate risk with short maturities because of how soon they come due, mostly 2013.

I've made a big deal over the past few years about owning individual issues of sovereign debt from other countries. Some yields are quite good and some are very low and we have a mix of both. Again these are short dated. Just about everyone has Australia and some have New Zealand (a little riskier than Oz) which is where we get decent yield. For Norway we rolled to 2015 when our 2011's matured in May and that yield is pretty good but not in the fours like Australia.

We have one closed end fund that we use as an across the board holding (we have a couple of other ones in our ownership universe). Relative to closed end funds this one is quite stable pricewise. The yield is pretty good as you can imagine and it does feel big market moves but it usually has a muted reaction when CEFs in general are puking down. It is a very old fund, and the reason not to mention it by name is there are plenty like this to find, research for yourself and then buy if you are so inclined. But again some of these get crushed, I specifically want one that is very likely to not get badly hurt. If you take more risk here than me then you will get a higher yield.

We have two preferred stocks that we use heavily; one from a big US bank and one from Public Storage. That might seem like a surprise given how lousy I think the banks are but thinking they won't go out of business is not really an argument for going long the common. The yields here are pretty good or like some of the other segments I've mentioned we could even say the yields are about "normal."

One other segment to mention is that we own the PowerShares Emerging Market Bond ETF (NYSEARCA:PCY). The bonds are dollar denominated but currency moves can move the price of the bonds. The yield is around 5% but as this is an ETF there can be no certainty about what future dividends will be. it is not terribly volatile but occasionally there is some noticeable movement.

We have a couple of other things but the point here is that the collective yield is not zero, I believe we have spread out normal market risks so that we are not over exposed to any one part of the market.

Bigger picture, I believe it is very possible to get some yield out of a portfolio but remain diversified--not selling out for yield at any cost.