Value Is Scarce Among Income-Generating ETFs
Written by David Fabian, August 03rd, 2016
The definition of value is a fierce debate among investors that seek to find intrinsically underpriced assets. Some stand their ground on historical fundamentals like price/earnings or price/book ratios. Others look strictly at price relative to other potential opportunities as a measure of opportunity.
The picture becomes even more complicated when you try to compare or overlay differing asset classes. Income investors often blur the lines between bonds, dividend paying stocks, and alternative income assets.
They trick themselves into thinking that the risk dynamics between all three are similar as long as they move in lock step with falling interest rates. That often leads to stretching for yield by taking on more interest rate risk or credit risk than most would be comfortable with during a contraction phase.
The combination of rising prices among virtually all income-generating asset classes over the last six months now has created a complex landscape for new money.
Where do you find value when prices are stretched and yields are at some of their lowest levels in years?
Below is a list of the income ETFs that I monitor on a daily basis along with their associated 30-day SEC yields and recent performance.
Flipping through longer-term charts (3 years or more) of these funds is an eye opening experience.
U.S.-focused dividend stocks, fixed-income, and even alternative assets are all trading within a percent of two of their highs. Similarly, their yields have fallen to meager levels on a relative and historical basis. One has to wonder about the future prospects for reasonable income and capital appreciation without the continued tailwind of falling interest rates.
The two areas of stark contrast are international dividend paying stocks and master limited partnerships (MLPs). Both of these indexes are still trading well below their prior highs and potentially offer further upside. Their yields also reflect a premium to traditional fixed-income and U.S. equity counterparts.
The trade-off in these asset classes is that both have experienced prolonged periods of underperformance and heightened volatility. At face value, that makes them a much riskier proposition for many conservative income investors who have opted for a home bias to capitalize on momentum and low volatility.
MLPs will, at the least, require stabilizing (preferably strengthening) energy prices to continue their recent ascent. The contraction in credit conditions alongside the collapse in crude oil prices was a double whammy for this sector in 2015.
Furthermore, international equities will need to break free of recession and low growth fears to have any hope of luring buyers back to the table. Many are also worried about ongoing central bank stimulus, political instability, and social issues that pervade developed and emerging foreign nations. Watching for signs of life in the price action of European banks via the iShares MSCI Europe Financials ETF (EUFN) is a good starting place.
- The current trend in U.S. equities, bonds, and alternative income assets is still intact. Nevertheless, caution should be warranted in adding new money at lofty levels.
- Trying to perfectly time an exit in these asset classes may be foolhardy given the propensity for trends to extend much further than most people believe.
- Areas of value have become more scarce in recent months and may require looking ahead to new avenues or incrementally changing your exposure to capitalize on fresh themes.
- Always remember that there is no such thing as a free lunch when it comes to the search for yield. Higher yield investments equate to a higher degree to capital at risk.
Need more yield? Download our free Ultimate ETF Income Guide to unlock the secrets of the top funds in each sector.