Where to Find Real Income These Days

12/15/2011 12:02 pm EST

Focus: INCOME

Richard Lehmann

Publisher, Forbes/Lehmann Income Securities Investor

Fixed-income plays are a must for investors in these volatile markets, but with the Fed holding rates down, Treasuries don’t cut it, says Richard Lehmann, who explains where else to look.

Richard, this volatility has a lot of investors quite nervous…however, traders love it. What should we do with volatility?

Well, income investors are always concerned with volatility, because they hate to see their statement showing a decrease in value. This is something I think equity investors are used to—seeing this up and down—but not so much for income investors.

It’s one of the phenomenons of what we call the "new normal" situation that we’ve had since 2008. But it’s something that income investors need to understand: this is not necessarily a negative, but it’s something that represents opportunity each time the market takes a downturn.

How should investors embrace this volatility?

Well basically, you buy a fixed-income secondary to give you a certain rate of return. The volatility does not affect that. The dividends don’t change. The yield on that instrument doesn’t change.

If it drops, it means there’s an opportunity to buy it at even a cheaper price than you had before. And if you can put the emotions aside in terms of seeing these short-term swings, and remember that the longer-term objective was a long-term income stream, you realize that this volatility is not necessarily something that is going to have any effect on you.

So look beyond that?

Exactly. You have to look at the income level that it’s paying you and what your long-term goals are.

Well, Richard, a lot of investors are concerned that you see the fixed-income market or the equity market move in tandem. Is this something unusual?

It is. In prior years, these markets have been separate. People invested in fixed income and the money that was in that market didn’t transition over to the equity market back and forth.

But these larger institutions and hedge funds have come in who really have no concern about the type of instruments, they’re just looking to make a dollar and they don’t care what type of secondary it is. So, we are seeing this movement of funds between the income market and the equity market, and this is why they tend to move in tandem and why they are so volatile.

What advice are you giving your clients now?

Basically, to look for good income opportunities now, because the Federal Reserve is managing both the short- and the long-term interest rates on high-quality debt instruments for its own purposes.

This creates difficulty for anybody who is used to buying CDs and Treasuries. They’re not going to be able to live on those anymore.

They need to find alternatives, and the alternatives are in basically the preferreds area, preferred securities being not just preferred stock but also mostly bonds actually.

Convertible bonds?

Convertibles, but also basically bonds that have been put in escrow and preferred shares issued against them, which are New York Stock Exchange-traded. These are good options and yield anywhere from 6% to 8%, which is way above anything that the bond market is paying…or Treasuries for that matter.

Can you share with us any examples?

In terms of that market, there are other types of securities in the energy field where we think there are great opportunities right now.

Oil has been fairly stable, and the Canadian oil corporations are paying significant dividends and distributions, and have very good reserves. Obviously, Canada is one of the safest places to have an oil investment.

The advantage here for investors is the fact that these Canadian corporations have to keep paying high dividend rates, because they need to keep the price of their stock high. Stock is what they use to acquire additional reserves, and since they’re constantly depleting their reserves, they’re constantly in need of replenishing them.

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