Income ETF Tips For the Fiscal Cliff


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One of the larger ETF themed investment conferences of the year, the Global Indexing & ETFs Conference, is being held in Phoenix, Arizona this week. The conference attracts a variety of entities including ETF Sponsors, professional investors and companies involved in the business of indexing. I had the opportunity to speak on two panel discussions focusing separately on income investing and actively managed ETFs. The more timely panel, given current political events, focused on Income Generating Solutions through ETFs.

We don't have to turn on CNBC to know that income investing is more challenging than ever due to the uncertainty surrounding U.S. tax policy going forward. Combine that with the historically low level of interest rates and income investing becomes downright vexing. In order to offer a bit of clarity, here are three takeaways from our conference panel discussion, as well as several related ETFs, that I believe are worth sharing with NASDAQ readers. 

First, it is clear that fiscal cliff negotiations are making it difficult to gauge the attractiveness of different income investment opportunities. In question for income investors are two issues: the level of increased taxation going forward and what types of securities and/or income will this taxation apply to. Already there have been over 100 companies in the Russell 3000 that have announced plans to pay special dividends before year end to avoid potentially unattractive answers to the above mentioned questions. Investors in the three largest dividend focused ETF including the Vanguard Dividend Appreciation ETF (VIG), the iShares Dow Jones Select Dividend Index Fund (DVY) and the SPDR S&P Dividend ETF (SDY) should be monitoring the special dividend trend as well as the outcome of the two taxation questions as they are likely to impact the attractiveness of dividend paying securities going forward.

Another theme from the discussion was that due to the uncertainty around tax policy, it appears that a trend to diversify income investments across asset classes is strengthening. Investors are going beyond dividend paying stock ETFs, for example, in order to find income opportunities in other asset classes. ETFs with focuses in areas with attractive income streams like REITs, MLPs, Senior Loans and Closed-End Funds were mentioned. Some of the leading ETFs in these categories include the Vanguard REIT ETF (VNQ), the PowerShares Senior Loan Portfolio (BKLN), the Alerian MLP ETF (AMLP) and the PowerShares Closed- End Fund Income Composite ETF (PCEF). Yes, diversification across securities and asset classes is always preached as a way to hedge investment risks but it might also be a way to hedge a portfolio against the risk of increased taxation on certain investments going forward. Only time - and a fiscal cliff compromise - will tell.

Finally, deflation and inflation concerns were both covered by the panel. The fact that these opposite risks were equally covered are yet another testament to the unusual climate income investors face. For the the most part, the panel seemed to be in agreement that asset classes producing income and categorized as "hard" or physical assets - including real estate and infrastructure - were attractive in both scenarios. The reasons cited by members of the panel regarding the attraction of these asset classes included their potential to increase distributions in the future and the tangible nature of each investment. The leading infrastructure focused ETF in the U.S. in terms of assets is the iShares S&P Global Infrastructure ETF (IGF). Keep in mind that MLPs and even utility-focused ETFs are often categorized as infrastructure as well. 

Income focused investors face a difficult situation today. Whether it is the likelihood of increased taxes or the plague of historically low interest rates, generating a healthy amount of income from a portfolio of ETFs or securities is not an easy task. Going forward this feat will become a bit easier as the tax landscape solidifies and market valuations of various income producing asset classes adjust to the new realities of the day. Accordingly investors should remain vigilante and nimble in their approach to generating investment income.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , ETFs , Economy , Investing Ideas

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Christian Magoon

Christian Magoon

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