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3 Equity Income ETFs That Laughed in January's Face

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A look at some income-generating equity ETFs that bucked the trend in January and registered positive gains.

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January got off to an inauspicious start with the major indices beginning the year in the red for the first time since 2009. The SPDR Dow Jones Industrial Average ETF (NYSEARCA:DIA) was one of the hardest hit areas and registered a decline of -5.20% for the month when the dust had settled. Clearly we are seeing an important shift in stocks that is signaling the 2013 appetite for risk is far in the rear-view mirror.

However, there were some select income-generating equity ETFs that bucked the trend in January and registered positive gains. Not surprisingly, these areas are tightly linked to interest rates and benefitted from the flight to quality that we saw last month. In fact, they are likely to continue their current strength if we continue to experience volatility in the markets that sends money flowing from high-beta areas to low-volatility names.

1. iShares US Preferred Stock ETF (NYSEARCA:PFF)
The first ETF on this list holds more than $8.5 billion in a basket of preferred stocks with a current 30-day SEC yield of 6.26%. This sector is typically dominated by preferred holdings in financial companies, real estate, and banks. While PFF hugged the flat line in 2013 due to heightened volatility in interest rates, it has already jumped 2.96% higher to start the year.

Preferred stocks are unique in that they offer both equity and debt characteristics. What this means is that their returns are often non-correlated to the broader market and can sometimes behave similar to bonds. As an alternative asset class, this ETF can be an excellent opportunity for an income portfolio positioned to diversify away from traditional dividend-paying stocks or low-yielding fixed income.

2. iShares US Real Estate ETF (NYSEARCA:IYR)
Another area of the market that was heavily beaten down in 2013, but is already on the rise this year is real estate investment trusts (REITs). The iShares US Real Estate ETF gained 3.44% in January and has been strengthening as interest rates continue their recent slide. This ETF has over $4 billion invested in 100 retail, commercial, and specialty REITs. The three largest holdings include the following: Simon Property Group (NYSE:SPG), American Tower Corp (NYSE:AMT), and Public Storage (NYSE:PSA). It is currently paying a 30-day SEC yield of 4.10% and dividends are distributed on a quarterly basis.

The biggest risk to the real estate sector moving forward is the threat of an additional push higher in interest rates which would act as a headwind for further upside. However, this sector is also going to be closely tied to the success of the housing market which has continued to show signs of improvement on a month-over-month basis.

3. Utility Select Sector SPDR (NYSEARCA:XLU)
Finally, the third sector that saw strong demand last month was utility stocks. The Utility Select Sector SPDR contains 32 large-cap companies and is market cap-weighted to propel this ETF to a total return of 2.98% in January. The top holdings include the following: Duke Energy (NYSE:DUK), NextERA Energy (NYSE:NEE), and Dominion Resources (NYSE:D).

Utility stocks offer numerous benefits including historical low volatility combined with a very generous dividend stream. They are considered defensive because of the non-cyclical nature of their revenue models and built-in consumer demand.

In addition, utility stocks can often exhibit an inverse correlation to interest rates because they are capital-intensive companies that rely on debt to manage their operations. Higher interest rates can weigh on their earnings and capital requirements, which makes these stocks more attractive in a falling-rate environment.

Going forward I expect that these three ETFs will continue to strengthen if interest rates remain accommodative. Another key factor in their success will likely be the fate of money shifting back to these areas as a defense mechanism against broader market volatility. While each of these sectors was underwhelming in 2013, that could change dramatically if we see dynamics in play that force investors to seek shelter in asset classes that offer strong income-generating properties this year.

Read more from David Fabian, Managing Partner at FMD Capital Management:

January Recap: Risk Off

How Much Of Your Portfolio Should You Dedicate To Closed End Funds?

Why Your Menu Of Active ETFs Is About To Get Even Better


Twitter: @fabiancapital
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Positions in IYR and PFF.
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