It's no secret that interest rates are at an all-time low and that investors who are looking for income are finding it increasingly difficult to generate. While preferred equities have often been mentioned as a great way to mitigate the lower yields offered by bonds, I think this investment has been overdone and has become increasingly risky.
Just last week, JP Morgan (JPM) and Citi (C) called several of their outstanding preferred equity issues in order to better manage their compliance with Basel 3 capital requirements. After all, if preferreds will not be considered as Tier 1 capital, why have a 7%+ coupon payment outstanding? And of course, the danger is the fact that these securities get called at par ($25) and in many cases are currently trading above those levels.
The better income generating investment is emerging market debt. I don't mean all emerging market debt, but there are certainly some attractive yields for good quality paper in Brazil, Colombia, Chile, and Russia. A well diversified portfolio can generate 1% in yield for every year of duration.
Most investors may be reluctant to invest in emerging market debt because the debacles of the past still resonate in their minds. But EM debt has evolved and is no longer the high yield/high risk play it used to be. In fact, many emerging market countries hold enough foreign reserves to withstand any currency issues. And many emerging market companies are global in nature and generate an increasing proportion of their revenues and profits from foreign markets.
For example, Banco Votorantim is the financial arm of Voto-Votorantim, a global conglomerate whose 2016 bonds pay 5.25 coupon, yielding 3.9% with a duration of 3.3. (Rated BBB-)
Hutchison Whampoa (OTCPK:HUWHY) 6% Perpetual with a call date in 2017 currently yields 5.1% with a duration of 4.3. Hutchison is rated BBB by S&P.
Bancolombia (CIB) 6.875% bonds maturing in 2017 have a yield of 3.99% with a duration of 4.3. Its rating is BBB-.
Itau (ITUB) 6.2% 2021 bonds have a current yield of 5.37% with a duration of 7.37. (Rated Baa1 by Moody's).
These companies and others, carefully selected, can provide much needed income in an environment where yield can only be found in long-dated paper. And with interest rates sure to rise over the next couple of years, you really don't want to be too long on the curve.