How to seek income with ETFs right now

Generating income remains a struggle for many investors despite the recent surge in government bond yields. Pat offers a few ETF ideas that may make it easier.

Government bond yields have surged higher in Canada and the U.S. since the summer, but that isn’t equating too much for investors trying to generate income from their portfolios. The roughly 1.7 per cent current yield on a 10-year Government of Canada bond is still well below its historical average over the past 30 years, according to Bloomberg data. Same goes for 10-year U.S. treasuries, currently yielding just close to 2.4 per cent after the significant jump in recent months.

As many fixed income investors have discovered in the low interest rate environment of the past several years, opportunities to achieve better levels of income exist, but thoughtful consideration of the potentially higher risks associated with the hunt for better yield is essential. Here are three ways to seek income through ETFs right now.

Bonds

It may be a while before government yields in the developed world rise enough to entice income seekers, but other areas of the broader global bond market may be attractive. High yield bonds that are part of the Markit iBoxx USD Liquid High Yield Index provide an average yield north of five per cent at the moment, according to Bloomberg data, and may continue to perform well in a cycle of improved economic growth. Meanwhile, emerging market bonds that make up the J.P. Morgan EMBI Global Core Index, currently offer similar yields and may benefit from global reflationary trends despite the potential challenge of higher valuations and a rising U.S dollar in the short term. A way to get exposure to these sectors is iShares series of strategic fixed income ETFs. These funds are managed to seek a balance between varying types of bonds so that yields are potentially enhanced, but risks are also considered.

Dividend growth stocks

Dividend stocks currently yield more than government bonds in major markets such as Canada and may remain a valuable source of income even as interest rates slowly begin to rise south of the border. That said, investors may want to consider dividend growth stocks going forward, rather than those simply offering the highest yield. Dividend growers are typically supported by quality companies with strong balance sheets and tend to hold up well in rising rate environments, according to BlackRock research. Notably, dividend growth strategies including iShares S&P/TSX Canadian Dividend Aristocrats Index ETF are less expensive than the broader S&P/TSX Composite Index based on price-to-book and price-to equity ratios, according to Bloomberg data, and may be a good opportunity to potentially generate a boost to a portfolio’s overall yield.

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Preferred shares

Canada’s preferred share market is another area of the market to consider. iShares S&P/TSX Canadian Preferred Share Index ETF has performed well over the past year and currently boasts a yield close to 4.5%. There’s potential for positive returns in the near future but a lot will depend on the direction of interest rates. Rate reset preferred shares, which account for a big share of Canada’s overall preferred share market, typically do best in an environment of stable or rising rates. As a result, the Bank of Canada’s current stance to leave interest rates unchanged given its concerns about the country’s lacklustre economic growth could be an important catalyst for preferred share performance going forward – especially when combined with the U.S. Federal Reserve’s projections for multiple rate hikes this year.

Pat Chiefalo is a managing director and head of iShares Canadian Product for BlackRock Canada.

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