Investment advisors today are frequently asked by clients where they can find an investment that has a good return, will maintain principal value, and won’t keep anyone up at night worrying about credit quality. Instruments that offer a high dividend or interest payment can provide a cushion in these volatile times. These investments have moved to the front burner in the aftermath of the housing market meltdown and the seemingly relentless rise in energy prices.
But where are these investments? You won’t find them in the typical places. As of June 2, three-month Treasury bills hover around 2%, six-month CD rates are under 4%, and money-market yields are in between. With these yields, the bottom line is not easy to stomach, especially in a taxable account. Inflation is over 4% annually, so the “real” yield on the six-month CD is basically zero. And this is before Uncle Sam has stepped in and taken his cut of 25% or so of the interest earnings.
As an alternative, BWFA has identified three attractive areas for picking up yield in the current market: trust preferreds, special situations, and high-dividend stocks.
Trust Preferreds are investment-grade stocks that possess fixed-income characteristics. They are publicly traded, and therefore their prices can easily be followed. Typically, they offer yields that are 3% to 4% above U.S. Treasuries. For example, 10-year Treasury notes today yield 3.89%, whereas a recently issued Suntrust Trust Preferred yields 7.85%.
Trust Preferreds can be purchased with an investment of as little as $2,500, which makes them very efficient for investors who are not super-wealthy. Many Trust Preferreds offer qualified dividends, so they are taxed at the low rate of 15%, which makes them attractive for taxable accounts.
However, it is important to realize that Trust Preferreds are not a “free lunch.” They usually have special provisions that require analysis to see if the yield is worth the contingencies that come with it. For example, Trust Preferreds usually have call provisions, like bonds. In other words, if the investor is getting a deal that’s too good, the issuer can “call in” the investment. Then a new place must be found to invest your money.
Sometimes, BWFA’s investment committee finds stock issues that offer both high yield and the potential for growth. An example is Allied Capital, a Washington, DC-based firm that provides financing and other services to the U.S. private equity market (specializing in mid-size companies). Allied Capital has either increased or maintained its dividend for each of the past 43 years, through up and down markets. In 2007, Allied Capital paid a dividend of $2.57/share. At today’s share price, this is a yield of approximately 13%. But its attractive yield comes with considerable price volatility, so it’s not a stock that a short-term buyer would purchase.
BWFA also considers publicly traded Master Limited Partnerships. These are typically in the oil-and-gas transport business. By contractual agreement, these partnerships have to pay out quarterly dividends at a fixed percentage of their earnings. Plains All American, which provides a yield in excess of 7% today, is one investment that BWFA finds attractive in today’s market.
BWFA is constantly searching for stocks that pay high dividends and offer attractive growth prospects, and we usually place them in the “Growth & Income” portion of clients’ portfolios. Because of their relatively higher tax rates they are especially suitable for tax deferred accounts.
Sometimes, BWFA finds these stocks when a company has experienced a sharp drop in price, and investors question whether the stock will maintain its dividend. These concerns are weighing heavily on the financial sector, thus opportunities may exist for long-term investors. For example, Bank of America’s dividend offers a yield in excess of 7%.
Seeking out-of-favor companies is not for the faint of heart, and owning those stocks requires constant monitoring. That’s why we make the selections judiciously and watch them carefully.
Final Note: Diversification
Here is one more point to share. In considering these various investment opportunities, BWFA is always mindful of the principles of diversification. For this reason, we normally limit our investment in a single stock to around 2% of an individual client’s total assets. Finally, we manage portfolios to limit exposure to any one industry.