ETF Trends
ETF Trends

A little over a year ago we looked at a new income vehicle called a yieldco which was highlighted in Barron’s. Over the weekend Barron’s provided an update on the still small niche and basically they’ve had a rough go in the last three or four months although I should note that for the six months prior they were white hot. Along the way GlobalX listed a fund that tracks the space and although not charted below it has also gone down considerably in the last few months.

The following chart from Google Finance (symbols erased for compliance reasons) gives a sense of what has gone on since early June.

As a refresher that first Barron’s article defined yieldcos as “a spinoff of renewable-energy companies, principally solar-power outfits, that is supposed to offer a solid dividend supported by stable cash flows and a high payout ratio.” A yield oriented niche that may not be directly sensitive to rising interest rates is worth learning about.

There are similarities between yieldcos and MLPs in terms of being based on cash flows and having high payout ratios and while that taxation is not the same, Barron’s posited that they soon could be, at least some of them anyway.

My take from a year ago on these was essentially I want to learn more but these are likely going to be very risky. At high level something that yields 7% in a zero percent world is going to be risky and if you don’t think that is the case then you probably don’t understand the risk. The factors driving down yieldcos appear to be the poor performance of energy prices with the thinking being if fossil fuels are cheap who needs solar? (I realize they aren’t necessarily substitutes for each other but they often trade that way) and the apparent slowing of the global economy which of course reduces energy demand. The reason the price declines have been so large might have to do with how levered the businesses tend to be.

The Barron’s article made comparisons to the early days and growing pains of REITs and MLPs with quotes about yieldcos being unproven which they are. I have no idea what the prospects for this space are but markets will reset themselves to lower energy prices at some point and slowing global growth will fade into healthier growth at some point and I tend to think that more often than not the risk of something cutting in half is reduced after it just cut in half. I would also think that the businesses will get to the point where they don’t have to take on so much leverage which if correct might make them less prone to dramatic declines.

I am not a buyer here, as Barron’s pointed out they are unproven but to the extent there will be new products like this that come along they need to be kept tabs on which is what this is post is for. A front row seat for how this space evolves will allow for more informed decision making once the up 50% in three months/down 50% in three months phase ends.

As I have been saying for years, the manner in which investors access yield will need to change and a little more volatility will probably be part of the bargain. Six percent yields with regulated utility-like volatility won’t be a realistic expectation.

By Roger Nusbaum, AdvisorShares ETF Strategist