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Two Unconventional Sources of ETF Yield

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Desperate times call for desperate measures. This has surely been the name of the game for yield hungry investors of late, mainly thanks to the Federal Reserve’s extremely low interest rate policy.

While the Federal Reserve continues to print more money to boost the economy, it seems that income-seeking investors have to comply with the low interest rate scenario for some more time (read Zacks Top Ranked Bond ETF: SHV).

More often than not, income-seeking investors, like retirees and pension funds, are mostly conservative in nature and unwilling to take additional ounces of risk for higher returns.

This assumption, however, has not been fully justified of late. The frustratingly low yields have continued to push these investors towards high risk avenues in order to generate more income (read Gold ETFs Meet Covered Calls in Brand New GLDI).

How to Play

Utilities stocks and funds have for long been known as rich dividend payers. However, the dismal performance of the sector has kept investors away. Similarly, high yield bond (Junk) investors are also facing a dilemma with the present circumstances. After continuing their dream run for the past couple of years, these products may be finally approaching a dreaded bond bubble (see Target Date Bond ETFs: Best or Worst Fixed Income Funds?).

Meanwhile, MLP and REIT ETFs have also had to face the heat of the fiscal cliff sell off in the latter part of last year. However, these ETFs, especially MLPs have come back strongly this year with many of them posting double digit returns for the year already. For example, the J.P Morgan Alerian MLP ETN (AMJ) and the Credit Suisse Cushing 30 MLP ETN (MLPN) have added about 12.5% and 13% so far this year.

Unfortunately, valuations are approaching sky high levels in many instances as more investors fall in love with these products. As a result, some investors might want to consider other avenues in order to generate income for their portfolios at this time.

With this backdrop, we would like to highlight three ETFs which seem rather unconventional and thus may be overlooked by many seeking income. Still, any of them could go a long way in satisfying the needs of yield hungry investors at this time:

Crossover Bond ETFs

Crossover bonds are those fixed income securities that belong to the lower end of the investment grade bonds and the higher end of non-investment grade bonds. Naturally, these bonds have are prone to being up/downgraded more frequently than those safely in the corners of their respective ‘grade’ levels.

This may be the sweet spot for yield and risk for some investors in the bond world, as it combines a high payout with a relatively low default risk. For this reason, it could be an interesting play for investors seeking a new way to play the market without trending all the way into junk, or up into the top of investment grade either (see 3 Reasons to Consider the Crossover Bond ETF).

Fortunately for investors the SPDR BofA Merrill Lynch Crossover Corporate Bond ETF (XOVR) captures these overlooked instruments. It tracks the BofA Merrill Lynch US Diversified Crossover Corporate Index.

After its inception in June last year, the ETF has not been particularly favored by investors as is clearly evident from an asset base of around $16 million and an average daily volume of close to 14,000 shares.

XOVR charges investors 30 basis points in fees and expenses and targets the intermediate end of the yield curve. It also carries moderate interest rate risk as is evident from an average duration of the ETF of 5.67 years. The ETF has 223 components in its portfolio.

The fund has returned around 6.26% since its inception and has a 30 Day SEC Yield of 3.26%. It currently has a Zacks Rank #2 or ‘Buy’.

Preferred Stocks

Preferred Stocks are hybrid instruments having characteristics of both equity shares and fixed income securities. They have a fixed rate of dividend on their face value but they are influenced by interest rates in the economy as well as credit rated like fixed income securities.

In terms of hierarchy of payments, these instruments usually get their share of payment after the bond holders but before the common stock holders of the company. Nevertheless, in this present low interest rate scenario preferred stocks can be a great source for high yields (see Complete Guide to Preferred Stock ETF Investing).

The iShares U.S. Preferred Stock ETF (PFF) tracks the performance of the preferred stock space as represented by the S&P U.S. Preferred Stock Index. The ETF charges an expense ratio of 0.48% and holds 310 components in its portfolio.

Its portfolio generally comprises of banks and other financing companies since these companies are generally issuers of preferred stocks in order to strengthen their Tier 1 capital without any additional core equity dilution.

The ETF has returned an impressive 18.25% for the fiscal year 2012 and pays out investors a yield of 6.02%. It has a 30 Day SEC Yield of 5.66% so it could be a great choice for yield-hungry investors in this environment.

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