How to Profit from the Income Investing Panic of 2015

Nicholas Vardy

Nicholas Vardy has a unique background that has proven his knack for making money in different markets around the world.
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It hasn’t been easy being an income investor over the past few years.

The Fed’s zero interest rate policy (ZIRP) has punished savers with its low interest rates since 2009.

Many retirees who depend on their accumulated savings have grown increasingly frustrated trying to eke out income from their hard-earned investments.

So it’s no surprise that over the past few years, these same retirees have piled into income investments that promised regular high-single-digit, or even double-digit, percentage income.

The promise of steady income — hearing the metaphorical cash register of regular returns ring every month or quarter — offered at least some semblance of stability in the face of Mr. Market’s relentless mood swings.

Alas, the slow and steady drumbeat of regular, steady returns from income investments of all stripes will face a huge challenge in 2015.

Recall that in May 2013, even the mere hint of “tapering” by the U.S. Federal Reserve caused the bottom to drop out from under virtually all previously “safe” income investments.

Within a matter of days, investors found that even if a diversified portfolio of, say, U.S. Real Estate Investment Trusts (REITs) boasted double-digit percentage yields, it could tumble by as much as 20%, cowed by the threat of rising interest rates.

And as Mark Twain observed, “History never repeats itself but it does rhyme.”

With the U.S. economy expanding, and the Fed widely expected to raise interest rates some time this year, I expect investors will see another interest-rate-related sell-off in income investments, similar to the one they saw in 2013.

Double-Digit Percentage Yields in a Zero Interest Rate World

That all said, there is something compelling about investments that generate high income, month after month, year after year.

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That’s why I hold quite a few of these high-yielding investments personally, as well as on behalf of my clients at my investment advisory firm, Global Guru Capital.

With all the caveats of an impending sell-off, here are three of my favorite, top-performing, double-digit-percentage-yielding income investments

1. iShares Mortgage Real Estate Capped ETF (REM) — 14.52% Yield

iShares Mortgage Real Estate Capped ETF (REM) tracks the FTSE NAREIT All Mortgage Capped Index. The index is weighted by market cap and screens constituents for size and liquidity. Most of REM’s holdings are in medium- and small-cap mortgage real estate investment trusts. REM has large allocations to two giant mortgage REITs, Annaly Capital Management (16.95%) and American Capital Agency (12.94%).

Unlike equity REITs, which generate income by managing properties and collecting rent, mortgage REITs are financial firms that engage in arbitrage on the spread between the short-term interest rate and income from mortgage-backed securities.

That’s why mortgage REITs are very susceptible to rising interest rate risk. Even small upticks in the short-term rate can have a significant impact on these firms’ profitability. Several mortgage REITs have cut their distributions and have performed poorly during past rising-rate environments.

REM yields an impressive 14.52%, pays dividends monthly and charges a fee of 0.48% annually.

REM generated a total return of 16.77% in 2014 and boasts an annualized return of 10.6% over the past three years.

2. UBS E-TRACS 2xLeveraged Long Wells Fargo Business Development Company ETN (BDCL) — 17.45% Yield

This investment tracks the Wells Fargo Business Development Company Index. The index mirrors the performance of all 26 Business Development Companies (BDCs) that are listed on the New York Stock Exchange or NASDAQ.

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The BDC business model is to lend to small and mid-sized companies at high-yield equivalent rates while also, at times, taking equity stakes in such companies.

Based on a market-cap-weighted index, this exchange-traded note (ETN) is highly concentrated with its top four holdings — American Capital Ltd. (ACAS)Ares Capital Corp. (ARCC)Prospect Capital Corp (PSEC) and Apollo Investment Corp (AINV). Those four holdings account for about 38% of its investments.

But BDCL adds a twist. By leveraging your investment by 2X, for every dollar of BDC stock it buys, the BDCL borrows another dollar. Given that most BDCs are paying relatively high dividends of 8-9%, BDCL yields about twice that — making it one of the highest-yielding instruments you can find.

BDCL yields 17.45% and pays out dividends quarterly. It charges an annual fee of 0.85%.

BDCL generated a total return of -16.04% in 2014. But that was after gains of 74.28% in 2012 and 32.6% in 2013, notching a three-year average return of 19.09%.

3. iShares Global Telecommunications ETF (IXP) — 12.32% Yield

Launched in November 2001, this ETF tracks the price and yield performance of the S&P Global 1200 Telecommunications Sector Index.

The fund holds 46 stocks in its portfolio, with the top 10 holdings making up close to 70% of the portfolio. The top stocks in the ETF include familiar names, like Verizon Communications Inc., AT&T Inc. and Vodafone Group Plc, with asset weightings of 16.10%, 14.37% and 7.49%, respectively.

IXP boasts a trailing yield of 12.32% and pays out dividends quarterly. The fund charges an expense ratio of 48 basis points a year.

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A big chunk of IXP’s eye-popping headline yield stems not from dividends, but from income generated by distribution of capital gains. This is unlikely to be repeated in the coming year. The ETF’s Securities and Exchange Commission yield is a much more modest 3.29%.

IXP generated a total return of -1.38% in 2014. Its three-year average return is 11.60%.

Here’s a word of warning.

As I’ve already noted, each of these income investments likely will be hit hard once the Fed starts raising interest rates later this year.

And for the mortgage REITs that make up a good chunk of iShares Mortgage Real Estate Capped ETF (REM), part of that sell-off may be justified.

But for these and other high-income-generating investments, you should view any panic sell-off, like what we saw in May 2013, as a buying opportunity.

As the British say: “Keep calm, and carry on.”

NOTE: Global Guru Capital is a Securities and Exchange Commission-registered investment adviser, and is not affiliated with Eagle Financial Publications.

In case you missed it, I encourage you to read my e-letter column from last week about the disparity between different global markets in 2014. I also invite you to comment in the space provided below my commentary.

Upcoming Appearance

Join me for the World MoneyShow in Orlando, Florida, Feb. 4-7 at the Gaylord Palm Resort & Convention Center. To register for free admission to the investment conference, click here or call 1-800-970-4355 and mention you are my subscriber. Use priority code 038045.

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