Income-Generating ETF Strategies for a Changing Market

With the Federal Reserve likely to hike interest rates ahead, yield-seeking investors have a number of fixed-income exchange traded fund options to help diversify a portfolio and still generate attractive payouts.

On the recent webcast (available on-demand for CE Credit), Tactical Income Strategies for the Modern Advisor, Matthew Bartolini, Vice President and Head of SPDR Americas Research at State Street Global Advisors, warned that investors have to contend with the potential Federal Reserve rate hikes and political uncertainty, which will affect many people’s ability construct a diversified and stable fixed-income portfolio with adequate yield generating potential.

While bond yields have dipped post-election, the fixed-income market has also been in a bull market for nearly four decades. Investors should not expect the good times to last, with bond volatility whip sawing for almost two years in anticipation of a rising rate environment.

Many have turned to the benchmark Barclays U.S. Aggregate Bond Index as a proxy for their fixed-income allocations, but Bartolini warned that exposure to the so-called Agg may now prove riskier than before. After the extended bull run in the debt market, the Agg has developed an undesirable risk/reward trade-off.

“The Bloomberg Barclays US Aggregate Index is approximately 70% allocated to interest rate sensitive sectors, and since the financial crisis the exposure is more concentrated in Treasuries and US corporate bonds,” Bartolini said.

Alternatively, Bartolini argued that investors should consider active or passive fixed-income strategies and floating-rate debt over fixed debt to help target better total returns in a higher rate, cyclical environment while achieving balance in a bond portfolio and align income with risks.

For example, the SPDR DoubleLine Total Return Tactical ETF (NYSEArca: TOTL) has been a popular active bond play for ETF investors. TOTL is an actively managed ETF backed by bond guru Jeff Gundlach and is also seen as an ETF adaptation of the flagship DoubleLine Total Return Fund (DLTNX).

“With TOTL, investors may rely on DoubleLine Capital’s experience to navigate today’s changing fixed income markets by allocating across multiple bond subsectors and applying individual security selection to potentially deliver improved risk-adjusted returns,” Bartolini said.

The actively managed SPDR Blackstone/GSO Senior Loan ETF (NYSEArca: SRLN) provides exposure to senior secured floating rate bank loans.

“Senior loans have historically outperformed high yield bonds when credit spreads widened, and may offer rising levels of income as their coupons begin to adjust with LIBOR, which is now over 100 basis points — the floor of 99% of the loans held in SRLN,” Bartolini said.

Additionally, the SPDR Barclays Investment Grade Floating Rate (NYSEArca: FLRN) focuses in investment-grade debt that implement a floating-rate component.

“Investment grade floating rate notes may provide some yield, but with a lower duration risk than fixed rate exposures — a potential benefit in a rising rate environment where duration induced price declines may wipe out any return from the coupon,” Bartolini said.

Bryan Novak, Senior Managing Director of Astor Investment Management, also argued that investors can combine non-correlating assets to mitigate risk in an income-focused portfolio.

“Investing in income streams across the capital structure can add significant value to a portfolio through changing the risk profile of the portfolio and sensitivity to any one specific risk event,” Novak said.

Given the current macro environment, Novak advised investors should look to short duration and positive credit, including options like SRLN as a high-yield option with a floating-rate component and the SPDR Barclays Short Term High Yield Bond ETF (NYSEArca: SJNK) for a lower duration avenue to high-yield corporates without a significant sacrifice in terms of yield.

Mike Dickson, Director of Structured Financial Solutions at Horizon Investments, also contends that investors should consider corporate credit and high-yield over everything else and shorter duration over long duration exposure.

For example, Dickson also pointed out that Horizon is overweight options like TOTL and SJNK.

Additionally, Dickson also suggested overweighting dividend stocks as a way to provide strong value, defensive and quality tilts. For example, the SPDR S&P 500 High Dividend ETF (NYSEArca: SPYD) takes the top 80 dividend-paying securities listed on the S&P 500 Index, based on dividend yield.  The SPDR S&P Dividend ETF (NYSEArca: SDY) holds firms that have a minimum dividend increase streak of 20 years for inclusion and follows a yield-weighting methodology that allocates a larger weight toward those with higher yields, so the portfolio leans toward more mid-sized companies.

Financial advisors who are interested in learning more about fixed-income strategies in the current market environment can watch the webcast here on demand.

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