With its constant ups and downs, investing in stocks is like a
roller-coaster ride. Investing in bonds, on the other hand,
usually isn't -- especially during the bond bull market of the
past 15 years.
While bond investors love to complain about the pitifully
small income stream bonds provide these days, they've grown
accustomed to growing and stable principal values. But that era
of good feelings is probably over. Bull markets ALWAYS come to an
end -- and it appears this time is no different.
As the Federal Reserve telegraphed its "tapering" plans and
even hinted at higher federal funds rates, the bond market
responded accordingly: It went down. This price chart of the
iShares Barclays 20+ Year Treasury Bond Fund ETF (NYSE:
paints a clear picture.
#-ad_banner-#At the height of "Taper terror," shares plunged
over 15%. Prices have recovered, but don't expect a quick return
to the bond glory days. If anything, investors should prepare for
The challenge that investors face daily is the need for income
and some type of bond or bondlike allocation to a portfolio. For
example, as an investment professional, I manage a handful of
different investment strategies -- among them a balanced
strategy. A balanced strategy requires a mix of both stocks and
bonds; the ratio will depend on what market conditions dictate.
Currently, my mix stands at roughly 75% stocks and 25% bonds.
But I'm constantly tasked with finding conservative
investments that also provide a decent income stream for that
allocation sleeve. The slowly deflating bond bubble not only
presents risk to principal value, the lack of quality income is
almost laughable. About six months ago,
I profiled two preferred-stock exchange-traded
that solve this problem. Here's an update on both.
PowerShares Preferred Portfolio (NYSE:
: Since I profiled this stock in November, PGX shares have only
risen about 4% versus TLT (the long Treasury ETF) which has gone
up a little more than 5%. However, PGX pays a hefty 6.2% dividend
yield, more than double TLT's. One of PGX's strongest traits is
the quality of its portfolio: Over 60% of the preferred stocks in
PGX's basket are rated investment-grade.
IShares S&P Preferred Stock Index Fund (NYSE:
: Shares of PFF have gone up a little more than 3.5%, thus
offering a bit more upside than PGX and definitely TLT. One
perceived weakness of PFF is the credit quality of its portfolio.
Only 15% of the basket is considered investment-grade -- but the
trade-off is a higher yield: 6.6% in PFF's case.
Risks to Consider:
The biggest risks facing PGX and PFF is the sector make up of
their portfolios. Over 70% of the holding in each are issued by
financial services companies, which are constantly under scrutiny
from regulators and the markets. Another risk is that many
issuers are retiring preferred stock debt. While diminishing
supply in preferred issues can create uncertainty for the
composition of preferred-stock ETFs, one positive outcome (at
least in the near term) is that a shrinking supply will support
prices, resulting in less volatility.
Action to Take -->
Preferred-stock ETFs like PGX and PFF have fared much better than
Treasury bond ETFs such as TLT. Based on better performance on
the downside and the gains in yield, investors should consider
both PFF and PGX as bond surrogates. With price stability and an
average yield of 6.4%, investors should experience a little less
volatility than comparable Treasury ETFs and have 10% or more
total return potential -- which is quite respectable for
fixed-income investments in a declining bond market.
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