This has been an interestingyear in thestock market .
As the market has been lifted to all-time highs by an
accommodativemonetary policy and aneconomy starting to fire on
all cylinders, long-term investors have profited handsomely
during the first half of the year. A pullback in August led the
Dow Jones Industrial Average to drop nearly 1,000 points before
stabilizing in the 14,800 range. Despite this setback,stocks are
still showing signs of strength that should last for the rest of
But the fuel powering the stock market has its drawbacks: Low
interest rates and accommodative policy have sent yields to
ultra-low levels while boosting stocks. In fact,income investors
have become so frustrated by the lack ofyield that this
year'sinvesting theme can be summed up in four words: the search
I learned from my colleague Nathan Slaughter'sDividend
Opportunities advisory that in 1984, one-year bankCDs paid an
astounding 10.4%. Yields of 9% were commonplace in the stock
market after the 2008 market crash. Today, the stocks in the
S&P 500index pay an average yield of just 2.02%. Even the
traditional high-yield sectors, like international utilities, are
only yielding about 4%.
Further cementing the dire yield situation, Nathan ran a
screen on all 12,592 U.S.-traded stocks and ADRs (American
depositary receipts) -- and found that only 170 stocks of the
12,592 pay dividends higher than 9%.
But high-yielding stocks do exist in this low-yield
environment. However, before I talk about one of my favorites,
it's critical to understand that with high yield comes high risk.
This stock is not suited for risk-shunning conservative investors
but rather for those investors who understand the risk and are
willing to accept it -- in return for mind-blowing yields.
My favorite stock in the ultra-high-yielding space is the
AmericanCapital Agency (Nasdaq: AGNC)
. This stock yields over 18%, which is amazing provided the
A REIT, orreal estate investment trust, is required by law to
distribute 90% of its profits back to shareholders, hence the
high yields. Mortgage REITs invest in real estate mortgages, and
an agency REIT is one that only invests in government-backed
mortgages. This lowers thecredit risk due to the government
insured nature of the mortgages.
Mortgage REITs typicallyleverage between six and 10 times
their actual funding level.Money is made on the spread between
the mortgage interest rate and the short-term interest rate. The
wider this spread, the more money a mortgage REIT can make thus
pass along to shareholders. This spread is the lifeblood of
mortgage REITs and is where the risks and profits lie.
Rising interest rateswill negatively affect many mortgage
REITs. However, those that invest in 15-year mortgages rather
than the standard 30-year have a stronger chance of maintaining
the high yield. American Capital Agency has transferred 42% of
its portfolio to these "safer" shorter-term mortgages. This
flexibility shows management's willingness to change with the
environment to maintain the high yields. It is myprime reason for
choosing this mortgage REIT as an investment.
In addition, Gary Kain, American Capital's president and chief
investment officer, gave shareholders further confidence:
"The second quarter was characterized by extreme volatility in
both interest rates and mortgage spreads. In response, we
remained highly disciplined with respect to our risk management
activities. We reduced the size of ourasset portfolio, adjusted
our asset composition to be more consistent with a higher rate
environment, and materially increased theduration of our hedges.
As a result of these actions and evolving market conditions, our
exposure to higher rates is lower than it has been in years, and
our 'pay-up' risk is now minimal."
Looking at the nitty-gritty of the company, its investment
portfolio totals nearly $92 billion of agency (government-backed)
securities, including more than $14 billion of net TBA (to be
announced)fair value mortgage positions. The company pays out
$4.20 per share in annual dividends. It boasts a price to book
ratio of 0.85 and appears well prepared to continue its
high-performing dividend yields.
Risks to Consider:
Interest rate spread risk is the primary danger to mortgage
REITs. In addition, there is a pending risk ofFannie Mae
andFreddie Mac being shuttered. This means that there would be a
shift in the security of the underlying mortgages. How this will
affect agency mortgage REITs is not clear. The Federal Reserve's
eventual exit from quantitative easing may also pose a danger to
mortgage REITs. Remember, there is a high risk involved with
obtaining these high yields.
Action to Take -->
I like American Capital Agency right now: Its price is off the
highs, and the metrics currently paint a compelling picture.
Other high-yielding mortgage REITs includes
Annaly Capital Management (
. Those who seekdiversification across the high-yielding mortgage
REIT space can invest in a mortgage REIT exchange-tradedfund like
Market Vectors Mortgage REIT Income Fund (
. ThisETF consists of 14 of the highest yielding mortgageETFs on
the market; the top two holdings, as you might guess, are
American Capital Agency and Annaly Capital.
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