Drama-Free Income from These 2 Funds

08/18/2011 7:30 am EST

Focus: ETFS

Benjamin Shepherd

Analyst, Breakthrough Tech Profits, Global Income Edge and Personal Finance

In this environment, it’s good to know there are a couple funds out there that can squeeze solid income from a low-income world, writes Benjamin Shepherd of Global ETF Profits.

On August 9, the Federal Open Market Committee (FOMC) moved to quell market fears. In response to Standard & Poor’s downgrade of US credit and a growing debt crisis in Europe, the FOMC announced that the Federal Funds rate would likely remained at “exceptionally low levels” though mid-2012, if not longer.

Although the announcement helped stabilize equity markets, Treasury yields have compressed, and the yield curve is now about the flattest it’s been since the 2008 financial crisis.

The move has left income investors between a rock and a hard place. Yield has been elusive during the past few years, and the Fed’s announcement will only make the situation more difficult for income-seeking investors. Thankfully, several exchange traded funds can meet their needs.

Master limited partnerships (MLP) offer attractive yields, and have become extremely popular with investors. The majority of the cash flows that MLPs generate are passed on to investors in the form of quarterly distributions.

These quarterly distributions include a portion that’s known as “return of capital,” a payment that reduces your cost basis, and isn’t taxed until you sell your investment.

Many MLPs own attractive, fee-generating assets in the pipeline business. Not only are these MLPs an excellent play on growing demand for energy, they’re cushioned from volatile commodity prices.

JP Morgan Alerian MLP Index ETN (AMJ)
An exchange traded note (ETN), AMJ tracks the Alerian MLP Index, a capitalization-weighted index comprising the 50 largest publicly traded energy MLPs.

The ETN is broadly diversified across the investable MLP universe, and its ETN structure allows it to track the index almost tick-for-tick with very little tracking error. JP Morgan Alerian MLP Index ETN sports a reasonable annual expense ratio of 0.85% and a huge 5.1% yield paid out quarterly.

Owning an MLP via an exchange-traded product doesn’t convey any particular tax advantage to fund holders. But MLPs pay low corporate taxes, which allows investors to enjoy higher yields.

SPDR S&P Dividend (SDY)
SDY is another attractive option in a low-yield environment. The fund tracks the S&P High Yield Dividend Aristocrats Index, which screens the S&P 1500 Index for companies that have increased dividends in each of the past 25 years.

The index then tracks the 50 highest yielders on a yield-weighted basis. Additionally, the maximum weighting for any individual holding is capped at 4%.

The index’s methodology results in holdings that are of a much higher quality than traditional high-yield offerings. After all, only rock-solid companies have been able to consistently grow dividends for the past quarter century. The fund’s holdings include companies such as Pitney Bowes (PBI), Consolidated Edison (ED), Kimberly-Clark Corp (KMB) and Clorox (CLX).

SPDR S&P Dividend’s expenses are low at 0.35%, and the fund yields 3.3%.

The yields on both funds are attractive for now. But I expect these yields to drift downward in the coming months.

The Fed has given investors clarity on its plans to maintain the current low rate environment. This means that bonds will remain out of favor relative to riskier equities, a situation that will drive down yields.

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