Yield-Generating ETF Opportunities in a Low-Rate Environment

Yield-hunting investors can still bolster a fixed income portfolio in a low-rate environment with targeted exchange traded fund strategies.

In the recent webcast, How to Find Yield in a Low-Rate Environment, Jason Bloom, Director, Global Macro ETF Strategy, Invesco, explained that we might be stuck in a lower-for-longer yield environment after the Federal Reserve stepped in with several programs targeting market liquidity. After the Fed’s intervention, U.S. credit markets have rallied with heavy primary issuance and strong retail investor demand.

Bloom argued that while most purchases have yet to take place, the Fed’s actions have sent a strong message of support to the markets. Trading and issuance have progressed to healthier levels across many fixed income market places, with corporate bonds setting several monthly issuance records over the summer. Consequently, valuations have grown significantly, especially in the corporate bond sector, leaving investors to turn to alternative sources of yield.

As a way to help income-minded investors achieve their goals, Invesco has highlighted yield-generating opportunities in municipal bonds, preferred stocks, and high-yield bonds.

Brian McMullen, Fixed Income ETF Strategist, Invesco, believed that despite this ongoing recovery, municipal bonds still offer compelling value and higher credit quality.

While yields are at 60-year lows in the municipal bond market, McMullen argued that taxable bonds still offer attractive income. Specifically, the ICE BofATaxable Municipal Bond Index showed a 2.24% yield as of the end of July 2020, compared to the 1.92% yield for the ICE BofAUS Corporate Index.

Municipal bonds also come with lower credit risks. Municipal bonds have a higher average credit quality, with an average rating of AA- compared to A- for corporate bonds. Historically, municipal bonds have exhibited lower default rates than other fixed income market sectors, with a 10-year cumulative default rate for investment grade municipal bonds at 0.10% since 1970.

ETF investors can look to Invesco’s suite of target-maturity BulletShares municipal bond ETFs to produce a laddered bond portfolio strategy, including:

The BulletShares ETF suite tries to combine the advantages of ETF investing with the benefits of individual debt exposure, including the potential ability to match income with future cash-flow needs. The BulletShares ETFs are designed to offer income-seeking investors an easily accessible means of building or managing a laddered income stream.

These defined-maturity bond funds typically buy bonds that mature in the year the ETF will terminate, ensuring that investors can collect the bonds’ face value at maturity, along with a steady income stream along the way. As such, investors are meant to buy-and-hold these securities until maturity.

Financial preferred stocks can also be an attractive yield opportunity. Preferred securities sit above common equity in a firm’s capital structure and often pay a fixed coupon, comprising a hybrid between equity and fixed-income, paying dividends that take priority over common stock dividends. Potential risks have diminished as Tier 1 Capital Ratios have improved dramatically since the Global Financial Crisis, revealing stronger financial health among banks.

“Preferred Stock continues to provide compelling yields compared to other income-producing asset classes,” according to the Invesco strategists. “By focusing on financial preferred stock, investors could also help introduce new sectors into portfolios with High Yield corporates dominated by energy and industrials.”

Investors can look to the Invesco Financial Preferred ETF (NYSEArca: PGF) to gain exposure to preferred securities with either fixed or floating rate dividends issued by financial institutions.

Lastly, investors can turn to high-yield corporate bonds for their attractive yields. High Yield bonds initially sold off aggressively in March as liquidity dried up, but the Fed has quickly acted as a backstop to help improve market liquidity. Despite the potential risks, fixed-income investors can find attractive yields in the junk bond category, especially with over $15 trillion in global debt, showing a negative yield.

Invesco also offers a line of target maturity high-yield bond ETFs, including:

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