A Hybrid Strategy for Income Investors

05/22/2012 11:00 am EST

Focus: ETFs

Jack Ablin

CIO & Executive Vice President, BMO Private Bank

Harris Private Bank CIO Jack Ablin shares some ETFs that income investors should consider, as the inflation trend that he is expecting will make bonds more vulnerable.

Jack, a lot of investors have used bonds as a way to seek income, but maybe looking forward, are there some other ways to be doing this?

Yeah, if you believe that there’s inflation sometime in our future, there should be probably other strategies that investors can use to generate income. I would look at more of what I’ll call a hybrid strategy; more of an equity base, or at least a replacement cost feature to the principal with income that comes off that.

So things like preferred stocks, with the PowerShares Preferred Portfolio ETF (PGX). And master limited partnerships…here, it’s difficult to gain access to them without really a big tax filing issue, but there is an Alerian MLP ETF (AMJ), I believe. It’s a total return swap backed by a bond by JPMorgan, which could be one way to get the income and the total return there.

You could look at real estate investment trusts, through iShares US Real Estate Fund ETF (IYR), or bank loans…these floating-rate LIBOR-based bank loans, via PowerShares Senior Loan Portfolio (BKLN).

These are just a number of ETFs that generate decent income. I’m going to say somewhere between 4% and 7% income, but what I like about them is the principal value of these generally will rise should inflation pick up.

So, do you suggest gravitating toward some of these income-producing ETFs, rather than, say, sector ETFs or index ETFs?

I do. I mean, it’s really more of an incremental step. It’s really just a matter of risk.

So we’ve got a whole population of bond investors who have this certainty of income, certainty of cash flow to move directly into the stock market. Which even though over the long term I do believe it is a much more favorably priced asset class, it may be too big of a risk leap for people that really do need some current income.

So these assets are a good intermediate step, where you get partially away toward equity. So you have equity-oriented valuations, but you still enjoy the high current income that bond investors really seek.

And it sounds like you might be saying if a person is invested in a bond fund, for example, they might want to look to shift out of that?

Yeah, I think so. Again, I believe inflation is down the pike at some point. We can’t continue to expand our monetary base. If we’re just denominating everything in dollars and we’re expanding the number of dollars, it just means that it buys less and less over time.

So eventually we are going to see some inflation. It’s going to be higher costs. And a fixed income investor, I feel, is vulnerable in an environment like that.

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