Fixed Income ETFs: When You Need Lower Risk

Consumer sentiment rests at a 26-year low. Bellwether General Electric (GE) misses the Street's expectations. And inflation nags at the backs of investors' necks.

If it walks, talks and quacks like a recession, then you had better be prepared to invest during one. Where might you go to minimize portfolio risk? Fixed Income ETFs.

There are quite a few income-oriented possibilities for the stock weary, but some have better prospects than others. For example, take a look at the iShares S&P U.S. Preferred Stock Index (PFF). With financials likely having hit their bottom alongside the Bear Stearns (BSC) bailout, depreciation in preferred shares (75% financial weighting) may have already found a floor. Meanwhile, it is offering a very handsome 7.22% yield.

And the appreciation potential is there as well. The iShares S&P U.S. Preferred Stock Index is currently 14% off its highs from May of 2007. Granted, the recession will likely keep preferred stocks from gaining significant traction. Yet, even 3-5% appreciation over 52-weeks would produce an annual gain in excess of double digits!

In my mind, this is low risk investing at its finest. Consider the fact that if financial companies sank another 20% over 52 weeks, iShares S&P U.S. Preferred Stock Index may drop 8%-10%. The yield on PFF would climb a bit, and one would offset the capital depreciation. No gain, no loss. In contrast, if common financial stocks went flat for a whole year, PFF would serve up an unbeatable income stream of 7%-8%. (Even better, if financial stocks became the 2008 leaders, PFF would benefit from "cap app" and the high yield.)

Another favorite in a recession that may reach across borders is the Emerging Markets Sovereign Debt Portfolio (PCY). As I have mentioned in previous columns, foreign bonds are one of the only asset types that have a slightly negative correlation with U.S. stock assets. No correlation and/or a negative correlation between assets in a portfolio represents a founding principle of diversification.

The emerging market exchange-traded vehicle, as dicey as it may sound, only holds government-issued debt. You don't have to worry about a company going belly up because a country itself would have to default. Also, the Emerging Markets Sovereign Debt Portfolio minimizes the risk of a single country defaulting by holding the debt of at least 20 countries.

Since its inception in 2007, PCY has served well both as a diversifier and as a source of income. It opened at 25 more than 6 months ago and it is trading in and around 26 today. That consistency has served income advocates well... as has the 5.7% current annual yield.

When it comes right down to it, in a recessionary backdrop the Emerging Markets Sovereign Debt Portfolio and the iShares S&P U.S. Preferred Stock Index both provide:

1. Higher-than-average annual yields.
2. Diversification alongside common stock assets.
3. Limited downside risk and genuine appreciation potential.

Disclosure Statement: ETF Expert is a web log ("blog") that makes the world of ETFs easier to understand. Pacific Park Financial, Inc., a Registered Investment Advisor with the SEC, may hold positions in the ETFs, mutual funds and/or index funds mentioned above. Investors who are interested in money management services may visit the Pacific Park Financial, Inc. web site.

Comments

[GeoffreyLordi]

Great points, Gary.

We've been in PCY for about 4 months in both ROTHs...Great income, and great price stability. Volume's light, but I haven't had much difficulty buying what we wanted...

[Tao Man]

I'm in PCY at a purchase price of 25.72 and as of today down 2.98%. So far I'd be better off in a money market fund. I like your arguments though - keep up with ideas on how to navigate this difficult environment. PFF may be attractive now that it is lower than when you recommended it.