Choosing 'All of the Above' in Your Income ETF

Photographer: Kaan Tanman/Getty Images

Photographer: Kaan Tanman/Getty Images

As interest rates play a little game of limbo with us, the challenge to income investors is growing. Plain-vanilla investments with decent yields are increasingly hard to come by.

Many economists and analysts expected rates to be higher by now. Instead, the 10-year Treasury bond yield has fallen 10 percent this year to 2.72 percent. Low global growth and accommodative Federal Reserve policy could weigh on rates for a long time, as Bloomberg TV anchor Adam Johnson notes.

His post highlights exchange-traded funds that cater to yield hunters in dividend-paying stocks, high-yield bonds, master-limited partnerships (MLPs), real estate investment trusts (REITs) and preferred securities.

Investors can also choose All of the Above with a multi-asset income ETF that packages all those high-yielding areas into one product. These ETFs have the freedom to go across different asset classes to fetch yield, which gives them very diverse portfolios and lowers their overall volatility to about half that of the S&P 500.

Here are two of the best ones in terms of yield, return, asset growth and true diversification across asset classes.

  • First Trust Multi-Asset Diversified Income Index Fund (MDIV)

This ETF is the broadest of the bunch. It has well-rounded and nearly equal-weighted exposure to categories including dividend-paying stocks (25 percent), MLPs (20 percent), preferred securities (20 percent), REITs (20 percent) and high-yield bonds (15 percent). In addition, half of its REIT exposure is in mortgage REITs, which are some of the least familiar high-yielding securities around. All this equates to a 5.9 percent yield and a year-to-date return of 5.4 percent.

MDIV is the fastest-growing multi-asset income ETF on the market, having doubled in size to $600 million over the past 12 months. And like its tech cousin the First Trust Technology Dividend Index Fund (TDIV) it has a lifetime streak of positive monthly inflows. MDIV is U.S.-focused, so globally minded investors may prefer the First Trust International Multi-Asset Diversified Income Index Fund (YDIV). It does exactly the same thing MDIV does but internationally. MDIV charges investors 0.60 percent of assets annually, about average for its peers. It trades 115,000 shares per day.

There's a downside to MDIV. Its diverse exposure and extremely low volatility mean it won't participate in much of the upside of the U.S. equity markets. Last year, for example, it rose 11 percent when the market was up 32 percent. If interest rates were to rise quickly, many of the holdings in MDIV could lose value. Mortgage REITs in particular, which yield about 15 percent, could be hit hard, since they use short-term loans to buy mortgage-backed securities and generate income from the difference between the two.

  • iShares Morningstar Multi-Asset Income Index ETF (IYLD)

This ETF is also broad-based, but tilted to the bond side, with 60 percent of assets in fixed income. It's global in scope, allocating 30 percent overseas. The breakdown: high-yield bonds (20 percent), emerging market bonds (20 percent), Treasury bonds (15 percent), mortgage REITs (15 percent), dividend-paying stocks (20 percent), corporate bonds (5 percent) and international REITs (5 percent). The mixture results in a yield of 6.2 percent and a year-to-date return of 7 percent, both of which lead its peers.

To get that mix, IYLD invests in 10 other iShares ETFs. It charges an expense ratio of .60 percent, which covers all of the underlying ETFs in the fund. IYLD has grown assets by 20 percent in the past year and sits at $121 million. It trades 53,000 shares a day.

IYLD's creative bond mix includes not just high-yield bonds, but emerging market debt denominated in both local currency and U.S. dollars. It also has exposure to long-dated treasury bonds via the iShares 20+ Year Treasury Bond ETF (TLT). That ETF was used as a risk stabilizer, but its 10 percent rise this year has made it one of the biggest drivers of the ETF's total return in 2014.

A bond-heavy approach weighed on IYLD last year, and it was up only 1 percent. Its other notable downside is a lack of exposure to MLPs and preferred securities.

While MDIV and IYLD are standouts, there are about 10 multi-asset income ETFs on the market. Other notables include the Guggenheim Multi-Asset Income ETF (CVY), the SPDR SSgA Income Allocation ETF (INKM) and the Arrow Dow Jones Global Yield ETF (GYLD).

And a new entrant was launched today -- the iShares Yield Optimized Bond ETF (BYLD). It will hold stakes in other iShares bond ETFs. Given the surprising performance of bonds this year and investors' continued need for yield, its timing looks good.

Eric Balchunas is an exchange-traded-fund analyst at Bloomberg. More ETF data is available here, and weekly ETF podcasts can be found here.

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