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In the search for fixed income, financial advisors are looking beyond bonds to alternatives — from the commonplace to the more arcane.
Some view certificates of deposit as an alternative to individual bonds in the current environment.
"If I don't want to outguess the direction of rates, the CD option gives me a very low risk way to get some yield," said Leon LaBrecque, CPA, certified financial planner and "chief growth officer" at Sequoia Financial Group, noting that the yields on six-month CDs vs. five-year Treasurys are converging.
"This means that the old-fashioned CD ladder will come back into style, with an additional advantage of cash flow," he said. "If you think rates might fall, you can ladder out to four or five years.
"The backstory is that this exacerbated a yield-curve inversion – if money flows into CDs and money markets and out of bonds, bond prices drop and yields go up."
Many clients who are looking past bonds are now considering dividends to generate more income from their portfolio, said Scott A. Bishop, CPA/PFS, CFP, executive vice president of financial planning with STA Wealth Management.
But he has a warning for investors who want to go this route: Those who chase yields through buying dividends, especially those who really chase yield through master limited partnerships and real estate investment trusts, will see that they will have a big surprise in stability given market volatility.
"They need to do it with eyes wide-open, as they could see 10 [percent] to 15 percent price swings," he added.
Responding to this type of client interest, he is investigating dividend yield and growth exchange traded funds, specifically reasonably strong and diversified ETFs paying 3 percent to 4 percent yields. This approach would provide a diversified portfolio in one holding that can either target higher yield or dividend growth, the latter for longer-term investors.
For his part, CFP Ashley Folkes, senior vice president of investments with Moors & Cabot Investment, has found that structured notes have grown increasingly attractive to investors because they often pay higher interest than regular corporate debt and usually track the performance of an underlying market or index. These instruments can provide some or most of the upside potential of the market but with options for downside protection.
Structured products such as brokerage CDs may be backed by the good faith of a company and may also be FDIC-insured, he said. Their duration is usually five years, and there is generally a cap on the rate of interest that may be gained or lost.
"This could be a good choice for a client who is very uncomfortable with volatility, due to the downside protection [available] against catastrophic loss and the participation in a portion of the upside," Folkes said.
Fixed income can also be achieved through socially responsible securities such as private debt impact notes, which provide loans for social enterprises or green projects. Funding may go to domestic or international projects and can be spread among thousands of loans, said Shane Yonston, CFP and principal advisor with Impact Investors, who has used these for about 15 years.
There may be a lock-up period of months or years with these funds, which are currently yielding from 2.75 percent to about 7 percent, he said.
"I might use several in a portfolio for funds a client doesn't need to touch, not adding up to more than 15 percent of the portfolio," Yonston said. "It's good to spread your fixed-income bucket across different classes, whether international or domestic, amount of liquidity, various micro-loans.
"You're diversifying by having different borrower types representing different risk factors," he said.
Advisors are also delving into more out-of-the-box strategies for income.
For example, Matt Chancey, CFP, investment advisor with ClaraPHI Advisory Network, uses the "buy-write" strategy, in which the investor buys a stock and sells ("writes") a call option, a month-long insurance contract that gives him or her the right ("option") to buy the stock at a discounted price. The sale of this contract then becomes a source of income.
This strategy is more appropriate for investors who are familiar with selling options and looking to generate income but may be afraid of bonds, he said.
"While selling covered calls is a well-known strategy, buy-write is not widely used due to lack of awareness and many not having a clear understanding of the risk factors," Chancey said. "Therefore, it's best to use money market funds that mimic this strategy and let a professional money manager do it."