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Income ETFs Taking Off? |
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Published: April 5, 2004
Spiders and Vipers -- these hardly sound like
investments for the more conservative income portfolio. However,
exchange-traded funds (ETFs) such as these are becoming increasingly
popular with the individual investor. (In case you’re wondering,
Spiders refers to Standard & Poor’s Depositary Receipts (SPY,
$114.64), aka SPDRs, while VIPERs stands for Vanguard Index
Participation Equity Receipts.)
Since the first ETF was launched in 1993, this unique
investment class has grown into a $160-billion industry. While ETFs have
been around for more than a decade, it’s only been within the past two
years that income-generating ETFs have arrived on the scene. Investors
can now choose between dividend-paying stock funds, fixed-income bond
funds, and even high-yielding REIT funds.
WHY BUY INCOME ETFS?
Income ETFs provide investors with a simple way to diversify their
portfolio of income-generating securities. More specifically, ETFs
provide a regular income stream that mirrors the returns of a specific
index or group of securities they track. Like stocks, ETFs trade on a
major exchange, typically the American Stock Exchange (AMEX). Like index
funds, however, they represent an interest in a basket of underlying
securities.
ETFs are managed funds, but their management fees are
minimal since they don’t require active stock picking. That means
management fees take only a small bite from your total returns. For
instance, the fixed-income ETFs we'll introduce you to below charge a
minimal expense ratio of around 0.15% to 0.20%. That compares with a
typical 1.85% management fee charged by many bond mutual funds.
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Of course, since ETFs trade in the marketplace, you
will need to pay commissions to buy and sell them. However, for the
long-term investor those charges are likely to be fairly insignificant.
ATTRACTIVE DIVIDENDS
The iShares Dow Jones Select Dividend Index (DVY, $55.59) is the one ETF
that tracks the performance of dividend-paying stocks. It pays quarterly
dividends and sports an attractive +3.21% dividend yield. That is
considerably higher than the average +2% yield for dividend-paying
components of the S&P 500. Launched last November, the fund invests
in the 50 highest-yielding companies in the Dow Jones U.S. Total Market
Index. These companies also must have a five-year dividend growth
record, a five-year average payout ratio (dividend/earnings) below 60%,
and an average daily trading volume above $1.5 million. The fund charges
a very reasonable 0.40% expense ratio.
SECURE BOND INCOME
Bond ETFs provide coupon income that mirrors the returns of a particular
government or corporate bond index. Like real bonds, the ETF is worth
more when interest rates decline and less when rates rise. But while
bonds mature and return your initial investment, your investment in bond
ETFs fluctuates in the same way as it does in stocks.
The iShares Lehman Aggregate Bond Fund (AGG, $102.79),
launched last September, offers diversified exposure to the most
widely-followed bond markets in all key sectors, including corporate,
government, mortgage-backed, and asset-backed bonds. The fund yields a
solid +3%.
More risk-tolerant investors might find the +4.83%
yield of the corporate bond holdings of iShares GS $InvesTop Corporate
Bond Fund (LQD, $111.59) highly attractive.
For conservative investors wanting to steer clear of
more volatile corporate bonds, the iShares Lehman 7-10 Year Treasury
Fund (IEF, $85.47) is a solid intermediate-term government bond fund. It
yields +3.62%.
And given that shorter-term bonds are less volatile
than longer-term ones, the iShares Lehman 1-3 Year Treasury Bond Fund
(SHY, $82.46) is a highly conservative investment with an apt trading
symbol (“SHY”). With the fund's safety, however, comes a reduced
yield of just +1.72%.
The newest offering in bond ETFs is the iShares Lehman
TIPS Bond Fund (TIP, $104.80). Unveiled in December, this fund tracks
inflation-protected government notes. It yields a hefty +5.78%.
These ETFs seemed timely when they were introduced and
the focus was on stimulating the economy. If the Fed now moves to hike
interest rates, though, then bond funds could be vulnerable.
HIGH-YIELDING REITS
REIT ETFs take the Real Estate Investment Trust (REIT) to the next
level. Simply put, REITs are companies that hold a portfolio of real
estate properties or real estate related assets. They pay regular income
and can be traded just like regular stocks. REIT ETFs bundle together
different REITS from a variety of sectors such as hotel, retail,
commercial and retirement residences. These funds have already had a
strong run up, delivering total returns of about +46% in 2003, but they
do offer impressive dividend yields.
Three REIT ETFs are now available: the iShares Dow
Jones U.S. Real Estate Index Fund (IYR, $ 109.42), the streetTRACKS
Wilshire REIT (RWR, $ 166.79), and the iShares Cohen & Steers Realty
Majors Fund (ICF, $118.40). IYR and RWR are diversified funds that track
over 80 different REITS. IYR yields +4.75% before an expense ratio of
0.60%. It returned nearly +47% in the past year. Although RWR yields
+5.42% and has a lower 0.28% expense ratio, its +45.6% total return was
about the same. The less-volatile ICF tracks 30 large-cap holdings but
offers a lower 3.99% yield before a 0.35% expense ratio. It returned an
equivalent +46%.
HANDY LINKS
Since about 70% of all ETFs are managed by Barclays Global Investors,
you can learn about most funds by simply going to their website at www.ishares.com.
You can find out more about the Wilshire REIT fund that we mentioned
earlier at www.streettracks.com.
For a good general site on ETFs, you might also want to check out www.etfconnect.com.
And finally, since most ETFs trade on the American Stock Exchange
(AMEX), you'll find a wealth of additional information at www.amex.com.
Income ETFs have gained a great deal of attention in
recent years, and you can expect to see more rolled out over the next
few years. ETFs that track tax-exempt municipal bonds (Munis) or
high-yield “junk” bonds are bound to make their entrance sometime
soon. Whether you are looking to diversify your portfolio or ramp up the
performance of your income-oriented holdings, income ETFs can provide
you with an inexpensive way to spruce up your returns.
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Please Note: The above article was merely a
small excerpt from an issue of our premium income newsletter -- High-Yield
Investing. In each issue Carla Pasternak presents
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