With rates at historic lows, investors can't rely only on bonds but also must look at equities
Retired people and those approaching retirement are particularly challenged in finding investments to help meet their income needs. With interest rates at historic lows, investors can't rely solely on bonds but must seek out opportunities in equity markets to capture attractive yields.
For example, dividend-paying equity investments have become a viable source of income relative to bonds and provide potential for capital appreciation. In fact, the S&P 500's dividend yield (2.2%) is beating the 10-year Treasury yield (1.8%) for the first time since the 1950s.
In addition to dividend-paying common stocks, some areas of the equity market offer investors the chance to capture high yields (4% to 7%) that compare favorably with many parts of the bond market. These areas are supported by healthy fundamentals and strong balance sheets.
In fact, unlike fixed-income coupons, their dividends may have growth potential, providing a built-in inflation hedge. In this environment, investors may want to consider securities from these areas.
MLPs
These tax-advantaged entities are a key component of the United States' energy infrastructure. Typically, master limited partnerships own and operate assets such as oil and gas pipelines, storage facilities and terminals, and equipment.
Most larger-cap MLPs operate “midstream” — meaning that they provide oil and gas transportation and storage for other energy companies. MLPs operate more than 400,000 miles of pipeline in the United States, a number that is expected to grow dramatically as more deposits are discovered and tapped.
Because of their unique position within the energy value chain, MLPs effectively are “toll collectors,” charging a fee for use of their assets, usually on a longer-term fixed contract. This makes MLP cash flows stable and predictable, and allows them to return large amounts of their operating cash flow to investors, with distributions in the 4% to 8% range.
REITs
A real estate investment trust owns and operates income-producing residential or commercial properties. To qualify as a REIT, a company must have at least 75% of its income and asset base tied to real estate investments and must distribute at least 90% of its net taxable income to shareholders annually.
Profitable REITs are a good source of stable dividends for investors.
Available in many categories, REITs have varying sensitivities to economic variables. For example, a shopping-center REIT may be sensitive to consumer spending, while an office building REIT may be more sensitive to white-collar-job growth.
With the 65-and-over category the fastest-growing age group, the outlook for health care REITs is fairly optimistic. We also expect stable profit and dividend growth in the senior-housing and assisted-living industries.
The long-term (five-plus years) nature of health care facility leases lends stability to dividends, which are as high as almost 5%.
PREFERRED STOCK
Preferred stock is a hybrid of common stock and corporate bonds. Dividends are similar to bond coupons, in that they tend to be fixed.
Price appreciation also tends to be capped, but because these securities are junior to bonds in the capital structure, yields are higher (currently 5% to 7%). Nearly 85% of preferred stocks are financials, but with banks returning to profitability, this may be a positive.
A portfolio comprising companies from those areas and high-dividend common stocks can help investors achieve their income needs. Those who feel comfortable with more volatility can garner higher yields, with growth potential and a capital gains upside.
Financial advisers can select individual securities themselves or go the mutual fund route. A select group of funds combines high-yielding equities.
James Wong is a principal at Payden & Rygel and co-portfolio manager of the domestic large-cap and global equity portfolio strategies.
