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Two ETFs: One for Income, One for Investors With an Appetite for Risk

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Plus, why we're not in a stock market bubble.

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There is constant chatter from pundits, professional investors, and people I strike up conversations with or get randomly paired with on the golf course about the market bubble we are in. Everyone wants to know when the market is going to decline from its dizzying heights. In fact, I question whether the market is at dizzying heights, and have doubts about whether the market is even in a bubble.

I did some calculations and conclude that if you had bought the S&P 500 (INDEXSP:.INX) at its top in March 2000 and held it until June 11, 2014, you would have made about 1.78% per year; if you include the S&P 500 current dividend, you would have made about 3.59% per year. This is not an exciting performance, and this return is below the S&P 500 average return, which is in the 7% range. We are still climbing out of a cataclysmic event, the market meltdown of 2008-2009, and this is after the market meltdown in 2000, the two events combining to burn fear in investors' minds. The notion that we are in a bubble seems to come from people looking at the bull gains and forgetting the depths from which the market is coming. The market has memory, because the market reflects investors' sentiments, and investors have memories. The market's memory still includes the ubiquitous fear at the 2009 market bottom.

The market's five-year bull advance is probably more a "tail" event, with the stock market coming back up to the levels of other assets that outperformed the equity markets. Gold, silver, US Treasury bills, Treasury bonds, and oil, among other asset classes, outperformed the stock market over the last 10 years. As I wrote in my book Winning With ETF Strategies, the decade that started in 2010 should be the decade of the stock market, if only to catch up to other asset class performances.

ETFs for Investors With a Risk Appetite

The shabby condition of our nation's infrastructure is frightening. Recently the federal government concluded that 63,000 bridges need extensive repair. Reports show that hundreds of bridges and tunnels are over 100 years old in the US Northeast Corridor; in this heavily trafficked area, the power supply system dates from the 1930s. Studies show that infrastructure improvement and repairs in countries around the globe will require trillions of dollars of investment. Demand for this sector is generally steady, since aging assets must be updated and replaced constantly. 

The investment proposition regarding infrastructure is not new. Vital to all economies are basic services such as electric and water utilities, roads, ports, and communications, both in emerging countries and developed countries. Companies involved in infrastructure have high barriers to entry, such as very large capital commitments, making the sector rather exclusive.

This asset class could be a good performer in the future. ProShares has added to its lineup the ProShares DJ Brookfield Global Infrastructure ETF (NYSEARCA:TOLZ). TOLZ invests in companies providing infrastructure such as transportation, communications, energy, and water assets. TOLZ invests only in those companies whose primary business activity is involved in owning and operating infrastructure. Excluded in TOLZ are those companies that supply construction and engineering services to the infrastructure industry. The ETF has international exposure, since only half of the companies held in the ETF are based in the US. Some of the countries represented are the UK, Canada, and Spain; companies in emerging market countries are also represented. Oil and gas storage and transportation, electricity distribution, and MLPs make up 69% of the sectors of TOLZ.

TOLZ requires that the companies in the ETF have more than 70% of cash flows derived from infrastructure business lines. To be included the companies have to be listed on developed markets exchanges. The trailing P/E ratio is a rather high 25 times; price/book is a lofty 2.53 times; TOLZ is weighted by a float-adjusted cap formula; its dividend is rich: 3.85%; its SEC 30-day yield is 4.58%.

An ETF for Income, With Protection Against Rising Rates

There is an increasing concern about interest rates rising as the Federal Reserve keeps repeating its intention to phase out monetary stimulus as soon as it can. It might be some time before interest rates rise, but it is a reasonable assumption to believe that at some point they will. And it will probably be sooner rather than later. Investors are searching for a high yield, but rising rates would cause a loss in principal, especially in longer term debt securities. Floating rate bonds and preferred stocks are prime securities to choose as a hedge against rising rates. Preferred stocks are a hybrid of bonds and stocks, and they offer higher yields than are available with many other securities. Preferreds pay interest on a periodic basis, usually quarterly. They are preferred because they receive dividends before dividends can be paid on common stock, and if a company is liquidated, the preferred holders receive their payment before common stockholders receive any payment.

The interest rate that variable preferred shares pay constantly changes. The dividend from the variable preferred share is linked to movement in benchmark interest rates such as LIBOR rates and US Treasury rates. Variable preferred prices, because they reset as interest rates change, are steadier than fixed-rate preferred stocks.  Preferred shares have increased benefits to corporations, which get a tax break on preferred share dividends.

Because of these features, PowerShares recently released an ETF that offers a high yield with a floating rate protection. The new ETF tracks the Wells Fargo Hybrid and Preferred Securities Floating and Variable Rate Index, and trades under the symbol VRP. This preferred stock strategy appears to be a good strategy for investors who are concerned about rising interest rates. The volatility that is troubling income securities investors could put pressure on other high-yielding products, especially those that have long-term maturities. The PowerShares Variable Rate Preferred Portfolio ETF (NYSEARCA:VRP) could deliver a higher yield than other dividend-focused counterparts and reduce the volatility of returns during various market cycles. The return on VRP has been good: As of this date its SEC 30-day yield s 4.62%, and its distribution yield is 5.23%.
 
Editor's Note: Max Isaacman is the author of Blizzard of Money, Winning with ETF Strategies, Investing with Intelligent ETFs, How to Be an Index Investor, and The NASDAQ Investor.
Max Isaacman and his clients hold shares of VRP.
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