3 ETFs that Deliver High Yields

05/30/2012 7:00 am EST

Focus: ETFs

Envestnet develops portfolios that advisors can use for retail clients. In this conversation, Tim Clift explains his firm’s process and discusses various methods for grabbing yield, including some junk-bond ETFs.

Kate Stalter: I’m on the phone today with Tim Clift of Envestnet. Tim, I think the best way to start out today is, describe for us what the Envestnet business model is.

Tim Clift: Sure, and good afternoon Kate. The Envestnet business model, you know, we’re basically a leading provider of technology-enabled wealth management solutions for investment advisors. So we service the investment advisor network and we help them, and I specifically help them design portfolios and provide investment solutions for helping their clients build portfolios.

Kate Stalter: So if any of the retail investors are interested in anything we’re discussing here today, what would be the best way for them to follow up with any of these ideas?

Tim Clift: They would reach out to their financial advisors. So we reach many, many thousands of financial advisors, and they would be able to use any of the resources that we’re talking about today.

Kate Stalter: OK. And just, again, to clarify a little further, when you’re talking about resources, are you talking about portfolios that you develop, or research you do…? Just kind of drill down into that a bit more.

Tim Clift: Sure. We do research on individual mutual funds and ETFs, and separate account managers. We build portfolios that individual investors end up getting invested into. We do white papers on a lot of the areas of the market, kind of any area from a research portfolio construction, portfolio consulting. Those are all the areas that we help advisors with.

Kate Stalter: To follow up on the idea of some of the research that you’ve been doing: I understand that the question of yield is something that you’ve been looking into. In this low-interest-rate environment, this comes up, Tim, in a lot of these interviews I do. Individual investors have been seeking yield. So, talk a little about some of your research in that area, and what you’ve found.

Tim Clift: Right. So we’ve been looking for areas to enhance yield, because, as we all know, interest rates are extremely low. The ten-year Treasury is at about 1.75% right now, and investors, particularly retirees that are living on a fixed income, they’ve seen that income drop.

So we’re trying to find ways of adding yield to portfolios, but doing it in a mindful manner, not just increasing the duration on portfolios. That’s really the interest-rate risk that you have by going farther out on the yield curve.

So we’re looking at different areas, like equities or different areas in the bond market, where we can find more yield and help diversify portfolios rather than just adding duration.

Kate Stalter: I understand that the ETF area is a place that you have been looking. What did you find with regard to this category?

Tim Clift: One of the areas, when we looked through the ETF universe—and there’s over a thousand ETFs out there now—we found that in 23 out of the 88 ETF categories, there was more than 5% yield. So you can get a pretty decent yield in more than just a couple categories.

So in your typical high-yield or emerging-market bond, you’d expect to see that. But there are other areas, like European stocks, or world stocks, or communications, where they also have much higher yields in some of the ETFs.

Kate Stalter: And how about MLP ETFs? Because that’s something that seems to come up frequently when I talk to advisors about ETF yield.

Tim Clift: That is another area, and that does come up within the ETF space. MLPs in general, you’re talking more about energy-related companies, and that can also drive yield, but you also can see a fair amount of volatility when energy prices rise and fall.

So I think it really depends on the type of MLP you’re looking at. If it’s transferring the energy, those tend to be a little bit more stable. If it’s more exploration, they tend to be much more volatile and cyclical.

Kate Stalter: Let’s talk about some specific investment vehicles that you came up with, either in equity or in some of the alternative categories. What are some findings that perhaps people might be surprised to hear about?

Tim Clift: Sure. There are actually a couple of different areas, even if we just stick with bonds for one second. I think the area we’re focusing the most on is the corporate-bond area, particularly the junk bonds.

Instead of being in more traditional corporate bonds, if you move out onto the B-rated or BB or BBB area, you can really increase yield. Right now, BBBs are yielding around 4%, BBs around 6%, and B around 7.5%. So there’s a bunch of ETFs right now that are in the high-yield space, and they have decent yields, generally between 5% and 7%.

So, the biggest ones:Â The iShares High Yield Corporate Bond (HYG) is one that’s yielding almost 7% The SPDR Barclays Capital High Yield Bond ETF (JNK) has about a 7.7% yield, and the PowerShares Fundamental High Yield Corporate Bond Portfolio (PHB), is at about 5.4%.

Definitely the yield is an indicator of how risky the bonds are inside the ETF, and we tend to like the higher-quality ones, so the PowerShares one that I just mentioned tends to have the highest quality. It’s going to give you a little bit lower yield, you know, 5.4%. But they’re sticking to B-rated bonds rather than the yield you’ll get—10% or 15% or 20%—with C-rated bonds, if you go into the higher-yielding ETFs.

Kate Stalter: And how about on the equity side?

Tim Clift: On the equity side, we like the mutual funds and ETFs that are focused on large-cap companies, and it’s almost the complete opposite when you look at the yield from a yield perspective.

On the fixed-income side, you’re looking at the riskier the bonds, the higher yield you get. On the equity side, particularly with these large-cap companies, when you see a higher yield, it doesn’t necessarily mean higher risk. In a lot of cases, it’s much more conservative companies, the pharmaceuticals and the technology and utilities, that don’t have as much volatility, but they have big cash flows and they’re paying them out.

So you can actually kind of mitigate risk and buy less risky companies on the equity side, by buying either ETFs or mutual funds that are focused on large-cap equities, particularly on the value side, that will produce more income and higher yield. They get 3%, 4%, or 5% in some cases.

Kate Stalter: I want to wrap up today by maybe bringing a lot of these different points together. How do you go about the process of developing portfolios? I know you’ve given a number of examples here, and I’m assuming you wouldn’t necessarily use all of these in any one. How do you determine the balance of which investments you might put into any particular portfolio?

Tim Clift: We really want to look at, when we’re building up portfolios, is the current economic environment we’re in right now. So, particularly for folks that are getting closer to retirement or are in retirement, you typically would see more and more money going into bonds. But right now, we’re at such low interest rates that bonds aren’t looking as attractive as they had, so you really need to start thinking about alternative sources of income.

So looking at equities that have higher yield in them, and we talked briefly about some of these alternative investments and some things called strategic income that can do long/short credit or long/short duration or long/short interest rates, that can have uncorrelated returns to the market, but still produce a fairly high amount of yield.

We like to see a lot of these different types of strategies, put into a portfolio, that aren’t dependent on interest rates, which is where the bond markets have been historically. So that, I think, when you’re looking at yields, the more diversity you can put in a portfolio right now that’s not correlated just to potentially rising interest rates, the better off an investor is going to be.

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