So, once again, the September meeting of the Fed held interest rates in super-low territory. As I noted last month, in the current era of extremely low interest rates, yield-starved investors are casting a wide net to find reasonably conservative investments that will improve on the low yields provided by investment grade bonds. This month we're going to take a look at a selection of five reasonably conservative exchange-traded funds that offer higher yields than the current anemic 1.7% yield on 10-year Treasury bonds or 2.1% yield on the S&P 500 Index /zigman2/quotes/210599714/realtime SPX +1.05% .
My selection process is simple, but surely not perfect, and there are many alternatives that will also work well. I have applied my own conservative bias to the selection process to identify five ETFs that are rated four or five stars by Morningstar and that offer a minimum 3% yield for the trailing twelve months (with one exception for a global ETF with 2.9% yield).
All five of these ETFs are rated by Morningstar as low or average for risk relative to their asset category and all have a large asset base to insure market liquidity and tighter bid/ask spreads. The selection excludes high-yield (junk) bond funds and emerging-market income funds to help yield-seeking investors sleep better at night. In my next column, we will move out on the return spectrum to pump yields up another percent or so, but recognize that we also will have to move out on the risk spectrum to do so.
1. Pimco Total Return Active ETF /zigman2/quotes/207852069/composite BOND -0.15% — 3.3% yield, Morningstar four stars, 0.57% expense ratio, $2.6 billion total assets — BOND is similar to the Pimco Total Return mutual /zigman2/quotes/206986610/realtime PTTRX +0.19% and the performance of both funds appears to have recovered from the departure of Pimco co-founder Bill Gross two years ago this month. Its expense ratio is certainly on the high side compared to passive competitors, but Pimco's active-management approach has outperformed the Barclay's Aggregate Index in each of the last three calendar years.
2. Vanguard High Dividend Yield Index ETF /zigman2/quotes/205740569/composite VYM +0.90% — 3.1% yield, Morningstar five stars, 0.09% expense, $15.3 billion — VYM is a conservatively positioned large-cap value fund which, typical of Vanguard, operates at a rock-bottom expense ratio of a measly nine basis points. As the name implies, the fund concentrates on higher dividend stocks which are weighted by market cap.
3. iShares Core High Dividend ETF /zigman2/quotes/203329283/composite HDV +0.93% — 3.5% yield, Morningstar four stars, 0.12% expense, $6.5 billion — Another excellent, low-cost entry in the large-cap, high-dividend space classified by Morningstar, as is VYM, as a large-cap value fund.
4. Vanguard FTSE Developed Market ETF /zigman2/quotes/202394679/composite VEA +1.13% — 2.9% yield, Morningstar four stars, 0.09% expense, $37.3 billion — VEA is a Vanguard index entry, with the typical Vanguard rock bottom expense ratio at nine basis points. The fund tracks the performance of the FTSE Developed All Cap ex-U.S. Index, which is made up of approximately 3,700 stocks of all cap sizes located in Canada and the major markets of Europe and Asia.
5. SPDR Dow Jones Global Real Estate /zigman2/quotes/206163567/composite RWO +0.47% — 3.1% yield; Morningstar four stars, 0.50% expense, $2.5 billion — Following up on last month's REIT column, RWO is a REIT ETF that looks particularly suitable to investors seeking yield combined with solid total returns. This is a global REIT that is invested approximately 60% in U.S. REITs and 40% in international REITs, and is the only large ETF that provides global exposure to the world REIT market in one package. The 50-basis-point expense ratio seems reasonable for a globally diversified fund.
Using the five choices above, if we create a hypothetical portfolio with 20% of the portfolio invested in each of the ETFs, we would have a portfolio with an average trailing 12-month yield of 3.2%, which is 1.1 percentage points higher than the 2.1% yield on the S&P 500. Better yet, as of 9/23/16, on a total return basis, this ETF portfolio would have earned 7.0% over the past three years and 11.2% over the past five years (using PTTRX as a surrogate for BOND for the 5-year calculation) compared to the S&P return of 10.7% and 16.2%, and the Barclay's Aggregate return of 4.2% and 3.0% respectively, for the same holding periods (note that a 60/40 S&P 500/Barclays Aggregate portfolio would have returned 8.1% and 10.9%, respectively, over these two time periods). Although we do know for sure that past performance does not predict future results, this certainly is an encouraging historical result for a diversified, high yield portfolio.
In the interests of full disclosure, I do not own any of the ETFs mentioned in this column in my personal portfolio, but I do own other Pimco and Vanguard mutual funds and other Vanguard and iShare ETFs.