A supercharged income ETF for your portfolio

This fund seeks to balance high quality and high yield, but with the market at these heights, it's not without risk.

By Minyanville.com May 22, 2013 3:21PM
Portfolio Account statement copyright Alamy Creativity, AlamyBy David Fabian

The search for income continues to be one of the most sought after investment themes of 2013, as investors pour billions of dollars into both fixed and equity-income ETFs.  

A quick look at year-to-date asset flows from Index Universe shows that investors are actively pursuing dividend-oriented funds such as the PowerShares Senior Loan Portfolio (BKLN) and the Vanguard Dividend Appreciation ETF (VIG).  Both of these ETFs have garnered over $2 billion in new money over the last five months alone. 

However, as the market continues to hit new all-time highs nearly every day, the yields on these securities are starting to get compressed to rock-bottom levels. 

 It is difficult to get excited about an equity-income fund like VIG that has a current 30-day SEC yield of 2.13% and whose dividends are paid on a quarterly basis.  Yields like this are ultimately the “new normal” that income investors are faced with as a result of the aggressive quantitative easing from the Federal Reserve that have pinned interest rates to the floor. 

The question many investors are asking themselves is: How can I generate the income and capital appreciation I need to fund my retirement and stay ahead of inflation at the same time? 

ETF provider Global X is attempting to combat that conundrum with a relatively new offering labeled The Global X Super Dividend US ETF (DIV).  This exchange-traded fund focuses exclusively on 50 of the highest yielding domestic securities that include common stocks, REITs, and MLPs.  The holdings within DIV are equal weighted with a 25% cap on each sector so as not to get over-allocated to any one asset class.  The current 30-day SEC yield is 6.22% and dividends are paid on a monthly basis, which are both attractive qualities for income seekers.
In addition, according to Global X Funds, the fund providers' website, “A low-volatility filter is also used in an effort to dampen the volatility of the portfolio, while additional filters are applied to exclude companies that are most likely to cut their dividends, as determined by the Index provider.”  The securities within the ETF are rebalanced on a quarterly basis. 

I believe that DIV represents a compelling argument for a portion of a diversified income portfolio that is seeking sector exposure to high yield equity and alternative investments.  While DIV is not going to represent the same style of core holding as VIG, it does have exposure to blue chip companies such as AT&T Inc. (T), Altria Group Inc. (MO), and Lockheed Martin Corporation (LMT).  It pairs that quality stock exposure with high dividend paying mREITS such as American Capital Agency Corp (AGNC), Two Harbors Investment Corp (TWO), and Annaly Capital Management (NLY), to name a few. The diversification among varying sectors, industries, and asset classes gives DIV a unique portfolio that balances high quality with high yield. 

One of the simplest mantras in income investing that pays to remember is High Yield = High Risk. Therefore I would recommend that you look to leg into a position like DIV in small increments in order to size the position correctly to your risk tolerance. In addition, because the market is on its highs, I would prefer to purchase this holding on a pullback in price to increase the chances of a successful long-term entry point.

Another strategy could involve plugging a fund like DIV into your existing portfolio as a sector position to work in concert with other core holdings.  Then you can consider adding to it during the next market correction to average in a more attractive cost basis.

Whichever tactic you decide to implement, keep in mind that even a small position in DIV can make a meaningful improvement to your total portfolio yield.  It is small additions like this that will help you combat the forces of inflation as well as add to your spendable cash flow. The one pitfall is the likelihood of additional volatility in comparison to typical blue chip stocks.  However, with appropriate risk management practices in place, a favorable investment outcome will likely be achieved.

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