The Quest For Yield

6/20/2011


Do meager interest rates have you yearning for higher income? The spread between corporate bonds and 10-year Treasurys is relatively wide versus historical norms. High-quality corporate bonds now yield 5.0%, exceeding the yield on the 10-year Treasury by 2.0 percentage points. Since 2000, the spread has averaged less than 1.6 points.

High-yielding investments often come with increased volatility. Consider the table on page 6. Preferred stocks as a group yield roughly 7.2% but have been more than three times as volatile as 7- to 10-year Treasury bonds based on the monthly standard deviation of returns over the last five years. In fact, preferred stocks, master limited partnerships (MLPs), and real estate investment trusts (REITs) have standard deviations well above that of the S&P 500 Index. During the credit crunch of 2008, preferreds, MLPs, and REITs tumbled at least 25%. High-yield junk bonds, which now yield about 7.2%, slid 26% that year.

Duration, listed in the table below, offers another way to measure bonds' risks. Bond prices tend to move in the opposite direction as interest rates, and the higher the duration, the larger the price change for a given change in interest rates.

COMPARISON OF INCOME OPTIONS
Income investors have many options. While high yields are tempting, they often entail more risk. For example, while preferred stocks yield 7.2%, they have a high standard deviation (volatility) of returns. Notably, preferred stocks tumbled 25.8% in 2008.
Total Return
Yield
(%)
YTD †
(%)
12
Mos. †
(%)
5
Yrs. †
(%)
2008
(%)
Standard
Deviation
(5 Yrs.)
(%)
Duration
(In Years)
Preferred Stocks
7.2
4.2
14.7
4.5
(25.8)
26.5
NA
Corporate Bonds — High Yield
7.2
5.0
17.4
9.4
(26.1)
13.7
4.4
Master Ltd. Partnerships (MLPs)
6.3
2.4
27.6
15.5
(36.9)
19.8
NA
Municipal Bonds *
5.2
4.4
4.0
4.8
(2.5)
5.2
8.4
Treasury 20+ Yrs.
4.3
2.9
2.7
7.5
33.7
14.5
17.0
Utility Stocks
3.9
7.4
19.6
5.5
(28.0)
15.1
NA
Corporate Bonds — Intermediate
3.6
3.6
8.5
6.9
(2.8)
5.3
4.4
REITs
3.5
7.4
20.6
2.9
(40.1)
31.7
NA
Mortgage-Backed Bonds
3.5
2.8
4.4
7.0
8.3
2.9
4.5
Aggregate Bond Index
2.8
2.8
5.3
6.6
5.2
3.6
5.2
Treasury 7-10 Yrs.
2.8
3.9
6.7
8.0
18.0
7.3
7.8
Treasury — Inflation Protected
2.6
5.1
8.2
6.8
(2.4)
7.4
4.8
S&P 500 Index
1.9
3.3
20.6
3.3
(37.0)
17.9
NA
Treasury 3-7 Yrs.
1.6
3.1
5.3
NA
13.3
NA
4.5
Treasury 1-3 Yrs.
0.5
0.8
1.7
4.2
6.7
1.6
1.9
* Taxable-equivalent yield using 33% tax rate.    † Through June 14.    ‡ Through May 31.    NA Not Available.

More conservative investors have plenty of options, although lower return potential generally accompanies lower risk. With intermediate-term corporate bonds yielding 3.6%, fixed-income investors can obtain a decent yield without taking on too much risk. Treasurys with 20 or more years to maturity deliver yields of more than 4%, while less-volatile notes with seven to 10 years to maturity yield 2.8%.

As the table above illustrates, the risk and return profiles of income investments vary widely. The Forecasts recommends that subscribers seeking income avoid the temptation of chasing yield. Instead, diversify your income holdings using different types of bonds as well as equities. Our buy lists feature several attractive income plays, including the five listed at below.

INCOME SELECTIONS
Company (Price; Ticker)
Div.
($)
Yield
(%)
Div.
Payout
Ratio
(%)
3-Yr.
Ann. Div.
Growth
(%)
Quadrix
Overall
Score
Abbott Laboratories ($51; ABT)
1.92
3.7
45
11
89
BlackRock ($193; BLK)
5.50
2.9
48
16
96
Intel ($22; INTC)
0.73
3.3
33
12
99
Microsoft ($24; MSFT)
0.64
2.6
26
11
95
Rogers Commun. ($37; RCI) e
1.49
4.0
49
15
91
Note: Quadrix scores are percentile ranks, with 100 the best.    e Estimated.

Current Hotline

Stock Spotlight

Individual Stock Reports

ISRs make stock research easy!

Perhaps the most valuable two page reports available anywhere.

All the data you would normally have to plow through years of 10-K filings, earnings reports, and reams of market data to assemble — yours all in one concise report.

ISRs contain our proprietary Quadrix scores — find out how we rate all the stocks in the S&P 500.

Visit us at individualstockreports.com