As Washington remains gridlocked and talk of a possible US Government default is widespread, many who are dependent upon bond interest for income are getting nervous. They have an understandable fear of holding the usually safe US Treasuries, but would seem to have little alternative. The stock market would also suffer if the worst case scenario unfolds, and moving to cash is not an option; they need income.
First, the good news; the bond market isn’t panicking. The benchmark US 10 Year Note yield has edged up over the last week or so, but there is no sign of a mass exodus from government paper. Similarly, the US Dollar has shown little sign of a collapse. This suggests that traders believe that the well trodden path of brinksmanship and a last minute compromise will be followed again.
I am inclined to agree, but for those heavily invested in the traditional bond market, some diversification may be a sensible precaution. No investment will be immune to the problems in the event of trouble for Treasuries, but some are likely to be less affected than others.
As interest rates have begun to edge up, stocks seen as dividend plays have lost value. The traditional defensive sectors such as utilities and telecom have been hit hard along with REITs and other high-yielding instruments. Interestingly, one sector with a high yield has not been affected to the same extent.
Master Limited Partnerships, or MLPs, are stocks that represent an ownership stake in oil and gas companies. They pass the majority of their profits on to shareholders in the form of dividends. For most investors, the Alerian MLP ETF (AMLP) represents an easy way to access this market.
As you can see, while AMLP is down around 5% from the July 16th high, there has been no precipitous drop. Oil and gas prices have held up well amidst all of the uncertainty, and a yield close to 6% gives decent income. It is not that AMLP or its components won’t come under some pressure if the situation worsens, just that, if oil and gas prices remain high, the reaction may be less than elsewhere.
The other area that could provide some protection is large, Dow component stocks that have yields in the middle of the range. Companies such as McDonalds (MCD), Proctor & Gamble (PG), Coca-Cola (KO) and Dupont (DD) may not be exciting, but relatively low volatility and yields of 3.43%, 3.29%, 3.23% and 3.17% make them a possibility.
These stocks, unlike the utilities and telecom sectors or Real Estate Investment Trusts are not highly leveraged, so they would avoid the double whammy of higher interest payments and lower relative yields in the event of a spike in interest rates.
It is important that those seeking income from their portfolio keep a large part of their money in products that provide a fixed level of return in dollar terms. If, within that context, you are looking to reduce exposure to Treasuries, then there are a couple of options to consider.
Municipal bonds have had a lot of bad publicity due to the continuing budget struggles of some cities and states, but the vast majority of issuers have come through the financial crisis intact. Picking individual bonds in this sector is, in my opinion, best left to the experts, so once again an ETF that reflects the sector as a whole may suit most investors. Something like the iShares S&P National Muni ETF (MUB) also has the added advantage of being easy and relatively cheap to hold for a short time.
As you can see, MUB has actually risen over the last week or so. Don’t let that fool you. Any actual problems in the Treasury market will send ripples through all bond markets, but, being one step removed, the Federal Tax free income from Munis will still likely appeal to investors. Once again, this isn’t about finding a “safe haven”, but about diversifying to reduce risk.
In an attempt to address the fears and concerns that investors have, I have written several times recently about possible courses of action to protect against a downturn in the stock and bond markets. Each time, I have said the same thing, but it is important enough to bear repeating here.
If you have long term investment goals, then whatever transpires over the next few weeks will most likely look like a blip on the chart ten years from now, so sticking to your plan is still the best course. If, however, you are heavily exposed to US Treasuries, then the above suggestions should be considered.