By Carla Pasternak
Interest rates near zero and record-low U.S. Treasury yields make finding good income investments a bit harder these days.
Don't get me wrong -- it's still possible to find attractive yields, but you need to know where to look. Some of my best ideas have come thanks to going off the beaten path and looking at asset classes overlooked by others. For example, I've locked in nice returns in the past by adding offbeat securities such as bank loan funds, trust preferred shares and master limited partnerships to my portfolios.
And luckily for income investors, I'm still finding plenty of fertile hunting grounds out there. To give you an idea, I've put together a quick summary of five spots where you can still find double-digit yields.
10% Idea #1-- Business Development Companies
Business development companies, or BDCs, are a dream come true for high-yield investors. Many of these companies -- such as BlackRock Kelso Capital (Nasdaq: BKCC) -- yield double-digits and share prices are soaring.
BDC yields are powered by making loans to small companies and passing along the earned income as distributions. They are similar to venture capital funds, giving retail investors the ability to profit from an area normally reserved for only the biggest investors. With bank credit still tight compared to a few years ago, BDCs are thriving as businesses have fewer options for financing.
Like real estate investment trusts (REITs), BDCs must pay out at least 90% of their net investment income as dividends to avoid paying income taxes. That's why they can carry high yields. If you want to invest, look for business development companies that consistently raise dividends (or at least hold them steady) and can cover their dividend with investment income.
10% Idea #2 -- Municipal Bond Funds
When is a 7% yield really 10%? When it comes courtesy of municipal bond fund. Municipal bonds, or "munis," are bonds issued by state and local governments to fund highways, hospitals and other public projects. What makes munis (and the funds that hold them) attractive is that the interest they pay is exempt from federal income taxes, and sometimes state and local taxes too if the bond is issued by your local government.
You'll be hard-pressed to find a muni bond fund that pays more than 10% as a headline yield. But what you should look at is the fund's taxable equivalent yield, which can exceed 10% for muni funds like Pioneer Municipal High Income (NYSE: MHI). The taxable equivalent yield is the yield you would need from a taxable investment (like a corporate bond) to match the tax exempt muni yield. [For more on investing in muni funds, read: How to Hide from the Dividend Tax Increase]
To figure your tax equivalent yield, simply divide the bond fund yield by 1 minus your marginal tax rate. For instance, if the muni is yielding 7.2% and you are in the 28% tax bracket, your taxable equivalent yield would be 10%. 7.2%/(1-0.28) = 10% You can buy individual muni bonds, but funds are a better choice for most investors since they offer instant diversification.
10% Idea #3 -- Rural Telecoms
Interest in telecoms is mostly confined to the major companies like AT&T (NYSE: T) and Verizon (NYSE: VZ), but I've found rich yields and a compelling story in a largely ignored part of the telecom sector -- rural landline phone companies. These quaint relics of an earlier age throw off huge cash flow and pay healthy dividends. Some, such as Frontier Communications (NYSE: FTR), have yielded up to 14% at some points this year (the yield is now around 9%).
The rural areas these companies serve are too small to interest the big cable and wireless companies. As a result, there is little price competition. You might expect their revenue to be shrinking, but that's not the case. The reason is broadband Internet service. Yes, customers are shedding landlines in favor of cellular service, but they are also signing up for broadband. For most of these companies, broadband is only a tiny fraction of their revenue base, so there are still plenty of growth opportunities to continue powering yields.
10% Idea # 4 -- High-Yield "Junk" Bonds
Junk bonds may sound like something for the recycling bin, but these investments can be safer than many stocks in one important way. If you own a Junk bond and the issuing company goes into default, you are in line to be repaid before any of the common or preferred stock holders.
The key to junk bond investing is understanding bond ratings. Anything Standard & Poor's rates "BB+" or lower is considered sub-investment grade, or junk. But despite their name, these bonds may be less risky than you think. During the credit crisis, junk bond default rates peaked at 12.9%, but have since come down dramatically. According to ratings service Moody's, default rates on junk bonds should fall below 3% this year.
The safest way to invest is with a junk bond fund. Like the muni bond funds discussed above, these funds offer diversification across companies and industries. And they also offer some nice yields -- the SPDR Barclays Capital High Yield Bond ETF (NYSE: JNK) currently yields around 10%.
One note of caution: most bonds have seen a sharp run-up lately. To make sure you don't overpay, check the net asset value of any fund and compare it to the share price before purchasing. These bonds generally trade near 90% of their face value, but some funds now trade above net asset value.
10% Idea #5 - Canadian REITs
Canada's strong property market allows these often overlooked REITs to pay generous distributions and healthy yields. Canadian REITs such as Scott's (SRQ-UN.TO) carry yields of up to 11.5% and pay monthly. Yields are high because these REITs, like their U.S. counterparts, pass along their income to shareholders to avoid paying income taxes.
Unlike U.S. real estate, Canada's property market is thriving. Occupancies average 97.4%, according to a June report by credit rating agency DBRS. Moreover, Canadian REITs are taking full advantage of low interest rates (even though they are now rising slightly) to refinance existing debt at historically low rates.
And don't worry about buying Canadian securities. Most U.S. brokers can fill orders on the Toronto Stock Exchange. Fidelity, E*Trade and Schwab all offer access. Buying Canadian shares can actually be as simple as buying those in the United States. At worst, it might take an extra phone call to your broker to tap into the double-digit yields.
The ideas mentioned above are just to get you started. And while the specific securities I mentioned offer high yields, they don't necessarily represent my favorite plays -- but they do offer mouth-watering yields. The main thing to remember is that in a low interest rate world, you don't have to settle for low yields -- you just need to do your homework, and get a little creative.
Disclosure: Neither Carla Pasternak nor StreetAuthority, LLC hold positions in any securities mentioned in this article.