The market environment has been very challenging for the income investors. Traditional income assets currently produce miniscule yields and some even fail to deliver above-inflation returns. Search for higher yields sometimes lures investors to risky assets.
Bonds had a terrible performance last year as investors ultimately realized that the three decade bull-market may be nearing its end. The situation changed earlier this year as many investors sought cover in “safety” of bonds due to emerging markets turmoil and concerns about the economic recovery. (Read: Best ETF Strategies for 2014)
However, the Fed will likely remain on taper track if the economy and the labor market continue to improve. Thus rates may begin to drift higher soon, resulting in losses for bond investors. High-yielding junk bonds in particular look very risky as of now.
Most high-yield stocks are from defensive sectors, which tend to underperform in a rising rate environment. (Read: 3 Energy ETFs to buy on Ukraine crisis)
High dividend yielding stocks can often indicate low future growth potential. Particularly if high dividend yield is a result of falling stock price, the stock may be risky and dividend may be unsustainable.
However, there are some unconventional asset classes and products that currently have high yield and a solid return potential.
Private Equity ETF—A Great way to profit from PE Market’s Strong Momentum
Private equity firms had a blockbuster year in 2013. Strong sentiment last year resulted in record fund flow with firms raising buyout funds totaling $143.5 billion last year, the highest level since 2008.
Outlook for this asset class remains positive, with improving global economy. Further, M&A and IPO activities remain robust.
If the stock market continues its uptrend and interest rates do not rise sharply, then the private equity market can maintain its positive momentum. Per CNBC, Tiger 21—a group of super-rich individuals (median net worth $75 million) sees private equity as the best opportunity in 2014.
Private equity also has a low correlation to the broader market and provides portfolio diversification.
While many investors are unfamiliar with this corner of the financial market, it is definitely worth a look due to its superior performance, positive outlook and low correlation with the stock market. (Read: Revenue Weighted ETFs keep crushing the market)
Private equity space is generally accessible only to super-rich and institutional investors but retail investors can access this space via an ETF.
PowerShares Global Listed Private Equity ETF (PSP - ETF report) tracks the Red Rocks Global Listed Private Equity Index. The index is comprised of securities, ADRs and GDRs of 40 to 75 private equity companies.
Currently the fund has 64 holdings with U.S. PE firms accounting for about 40% of holdings, followed by UK and France at 18% and 9% respectively.
Expense ratio of 2.19% is certainly high but the product sports an excellent yield of 13.2% currently. The ETF returned 37.1% in 2013 and is up about 6.5% in the last 3 months.
Investors should however remember that this asset class may perform worse than the broader market during periods of prolonged market turmoil.
During the financial crisis, private equity space and this product had a terrible performance. So, this investment will need to be monitored carefully.
Covered Call ETN--A Safer Way of investing in and extracting income from Gold
Many investors avoid holding gold in their portfolios since it does not generate any yield. I believe that investors should have a small exposure to gold as the shiny metal has low correlations to stocks, in addition to being a safe have asset and an inflation hedge.
After an ugly performance last year, gold has rebounded strongly this year—up more than 12%. However a rising US dollar and low inflation may keep the gains in check. That said, long-term outlook for precious metals doesn’t look bad given rising middle class wealth in China and India.
Credit Suisse Gold Shares Covered Call ETN (GLDI - ETF report) is interesting and safer way to play the precious metals, while receiving an excellent income flow. (Read: Gold ETFs meet covered calls in GLDI)
This ETN tracks the Credit Suisse NASDAQ Gold FLOWS 103 Index. It uses a covered call investment strategy on a notional investment in the SPDR Gold Trust ETF (GLD - ETF report).
Basically, the product invests in GLD and sells out of the money call options on the position on a monthly basis, to add income to the position. So if gold prices slide, this product will provide some protection to investors.
Upside potential for the notes is rather limited (beyond 3% monthly move) due to covered calls; but I don’t expect a huge surge in gold this year.
The product has an expense ratio of 65 bps and yields 11% as of now. Investors also need to note that trading volumes for the product are low resulting in high trading costs. Further, since the product is structured as a note, it is exposed to the credit risk of the issuer.
The note outperformed the precious metal by 3 bps last year—not great but not bad at all considering the huge income potential and downside protection. The product has returned more than 9% this year.
The Bottom Line
Products with fat yields in general have a poor outlook in the current environment. But these unconventional ETFs not only pay out double-digit yield but they have also been beating the market of late and may continue to do so in the coming months.
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