The reason that income trusts are so beloved is that many investors see them as the only thing standing between them and guaranteed investment certificates and bonds paying a penurious 3 to 4 per cent.
That would be wrong. To prove it, this edition of the Portfolio Strategy column offers a six-pack of overlooked income plays that offer a good alternative to bonds and guaranteed investment certificates. The yields aren't as high as many trusts offer, but that's the price you pay for avoiding the uncertainty that lies ahead for trusts as they await a new federal tax that takes effect in 2011. Here are the six income alternatives.
Master Limited Partnerships
Overview: Meet the U.S. version of the income trust. MLPs operate under very tight rules about what kinds of businesses they can operate and who can own them, with the result being that they're fairly obscure. Still, they offer many of the same benefits as trusts, including yields in the 6- to 7-per-cent range. MLPs run pipelines and are involved in mineral or oil exploration, production, refining and storage. Most are listed on the New York Stock Exchange, but a few trade on the Nasdaq Stock Market and the American Stock Exchange.
The good: An income flow that's similar to a lower-yielding trust.
The bad: No one's targeting MLPs right now, but you can't entirely dismiss the possibility that they'll be subjected to the same kind of tax hit that income trusts face.
Availability: You can buy them individually through any broker, or through NYSE-listed closed-end funds that hold a diversified MLP portfolio.
Risk level: You saw what happened with trusts.
How to use them: Apply sparingly to wring a little more income from your portfolio.
More info: Alerian Capital Management, a U.S. investment firm specializing in MLPs, has a good primer available on its website at alerian.com -- just click on the "About MLPs" link.
(preferred share version)
Overview: Split shares are all about packaging. An investment management firm will take a basket of stocks -- banks or insurers, for example -- and then split them into two investable products. One is a capital share, which allows investors to benefit from any price increases in the basket of shares. The other is a preferred share, which siphons off dividend income from the basket and thus caters to income-seeking investors.
The good: You can get yields of 4 to 6 per cent from exposure to reliable blue-chip stocks, and you can often (but not always) use the dividend tax credit to lower the amount of income tax you'll pay in non-registered accounts.
The bad: These are just for income -- you have little chance of seeing your preferred split shares rising in price.
Availability: They're TSX-listed, but low trading volumes mean you may have to pay a bit over the current market price.
Risk level: Barring catastrophic losses in the underlying stocks, you should get your upfront investment back at the end of a set lifespan.
How to use them: Like any preferred share, which means like a bond with a higher level of risk than you'd get with provincial or federal government debt.
More info: Go to Globeinvestor.com and type "split" into the search box located on the top right of the home page.
Overview: Closed-end funds are actively managed mutual funds that trade like a stock. They're different from ETFs, which are passive investments that usually mirror a stock or bond index. Closed-end funds offer a wide variety of income-oriented products, many of which use income trusts. However, there are lots of trust-free funds that hold things such as preferred shares, bonds and dividend stocks.
The good: Lots of niche funds with yields of 5 to 8 per cent.
The bad: These funds can be more complex than they seem because some use leverage (borrowing money to increase returns) and derivatives to enhance returns and provide tax benefits; also, some funds are trading at prices that are above their net asset value. (It's much better to buy funds when they're trading at a discount.)
Availability: Trading can be thin, so be prepared to pay a premium.
Risk level: Ranges from moderate to high, depending on how aggressive a fund's strategy is; be sure to read the prospectus and don't buy what you can't understand.
How to use them: Small positions in these funds can help add yield to both the bond and equity sides of your portfolio.
More info: Go to Globefund.com and look for the "closed-end funds" link in the Fund Reports area.
High-yielding common shares
Overview: The most desirable blue chips are not the ones with the highest dividend yield, but rather the ones that increase their dividends often and by substantial amounts. That said, there's a role for a stock that offers a higher-than-normal yield if you're an income-hungry investor who can accept that the tradeoff for a juicy yield is a heightened level of risk. A good example is Rothmans. Its shares yield about 5.7 per cent these days because of concerns that cigarettes are a sunset business. And then there's Manitoba Telecom Services, where a yield of 5.9 per cent highlights concerns about the sustainability of the dividend. Another high-yield stock of note is Russel Metals, a metal fabricating company that has raised its dividend impressively in the past few years and now yields around 5.6 per cent.
The good: Yields of between 5 and 6 per cent and favourable tax treatment through the newly enhanced dividend tax credit.
The bad: High yield = more risk than with lower-yielding blue-chip stocks like the banks. Though dividend cuts are a public relations disaster and a complete humiliation for a company, they do occur.
Availability: Through any broker.
Risk level: Comparable to trusts.
How to use them: Mix some exposure to high-yielding companies in with your dividend growth stocks to juice up the flow of dividend income.
More info: Globeinvestor.com
Yield Hog ETF
Overview: This new exchange-traded fund (CVY-Amex) is like a U.S. version of those very popular Canadian mutual funds that hold a variety of income-producing assets in order to generate a flow of income for investors. The Yield Hogs ETF holds a mix of MLPs, real estate investment trusts, U.S. and global dividend stocks, preferred shares and closed-end funds. In other words: If it trades like a stock and generates yield, it's probably in this fund. There's no yield yet from this ETF because it's too new to have paid out any cash yet, but indications are that it could be in the 5- to 6-per-cent range.
The good: A widely diversified package of yield-producing securities with a decent yield.
The bad: The management expense ratio of 0.6 per cent is high in relation to the anticipated yield.
Availability: Any broker.
Risk level: Five interlisted Canadian income trusts were among the top 10 holdings as of Aug. 31; plus, the Yield Hog strategy is unproven in the real world.
How to use: Like income trusts.
More info: claymore.com
The Northern Rivers Monthly Income and Capital Appreciation Fund
Overview: This new mutual fund uses a portfolio of stocks, bonds and some income trusts to generate a monthly flow income yielding close to 6 per cent on an annual basis. Tax-efficiency is a major attraction with this fund, which uses a derivative strategy to deliver income that is treated almost entirely as a return of capital (this has the effect of gradually lowering your purchase price and thus increasing your potential capital gains when you eventually sell). Northern Rivers is a five-year-old money manager for high-net-worth investors, and this fund is its first product for a broader audience.
The good: A competitive yield, potential for capital appreciation and much better tax treatment than you'd get from bond or GIC interest.
The bad: This fund is unproven, and the MER is sizable at 2.4 per cent. Note: the minimum investment is $25,000, but you can buy in for as little as $2,500 over the next few months.
Availability: Major brokers.
Risk level: The prospectus says investors must be able to accept a "medium to moderately high" level of risk; though there are trusts in the portfolio, the fund has not been hurt by the government's trust crackdown.
How to use: As a generator of monthly income in non-registered accounts.
More info: northernriversfunds.comBeyond income trusts
There are several different ways to generate investment income without using income trusts and without resorting to the low yields offered by bonds and GICs. Here are alternative incomefocused investment classes, along with some specific examples of what's available. Use them as a starting point for your own research.
Five U. S. listed closed-end funds that invest in Master Limited Partnerships
|Energy Income & Growth||FEN - AMEX||$24.29||5.80%|
|Opportunities||FMO - NYSE||22.09||5.7|
|Kayne Anderson MLP|
|Investment Co.||KYN - NYSE||31.08||5.8|
|Infrastructure||TYG - NYSE||34.77||6.1|
|Tortoise Energy Capital||TYY - NYSE||26.16||6|
Five preferred split shares listed on the Toronto Stock Exchange
|BNN Split Corp.||BNA.PR.A||$26.00||6.00%|
|Dividend 15 Split Corp.||DFN.PR.A||10.47||5.1|
|Financial 15 Dividend Split II||FFN.PR.A||10.85||4.8|
|Brompton Split Banc||SBC.PR.A||10.75||4.9|
|Cdn Life Companies Split||LFE.PR.A||10.95||4.8|
Five income-oriented closed-end funds listed on the Toronto Stock Exchange
|Aberdeen Asia-Pacific Income||FAP||$8.38||8.60%|
|Bayshore Floating Rate|
|BG Advantaged Corporate|
|BluMont Man Alternative Yield||BMY.UN||7.88||7.6|
|Preferred Securities Income||PFS.UN||19.96||7.2|
Five high-yielding common shares listed on the Toronto Stock Exchange
|Manitoba Telecom Services||MBT||43.46||6|
SOURCE: GLOBEINVESTOR. COM
© 2007 The Globe and Mail. All rights reserved.
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