Bloomberg News

A New Breed of ETFs for Income-Hungry Investors

August 29, 2012

It would make sense for Atlanta-based financial adviser Mitchell Reiner to feel threatened. For two decades, the Wela Strategies adviser has managed portfolios for retired clients by emphasizing income and consistent cash flow, most recently through an assortment of exchange-traded funds. In April, though, State Street Global Advisors launched its SSgA Income Allocation ETF. The actively managed ETF can move in and out of some 20 State Street ETFs, holding everything from emerging market bonds to preferred stocks in order to generate consistent cash flow and stable returns -- much as Reiner does.

Such ETFs are a new breed. In the past, ETF developers favored increasingly narrow slices of the securities markets. They designed products with advisers such as Reiner in mind -- those wanting to allocate client portfolios as precisely as possible, be they in mortgage bonds or Japanese small-cap stocks. Most of the ETFs tracked an index, making them easy to slot into a portfolio without worrying that they'd shift focus and mess up a carefully calibrated asset mix.

The State Street ETF turns that model on its head. It is one of a handful of so-called multi-asset income ETFs that offer a one-size-fits-all solution for income-hungry investors. Reiner is a little skeptical: “I just don’t know how much owning one ETF will satisfy investors’ needs for retirement solutions,” he says.

Starved for Yield

State Street says clients now want more from their ETFs. “We hear the same two questions from both institutional and individual clients,” says Christopher Goolgasian, State Street’s head of U.S. portfolio management investment solutions group. “What could I have done differently during the 2008 credit crisis and what options do I have in this yield-starved environment?”

The answers to those questions are largely the same, says Goolgasian: Try to navigate the markets better by using an investment strategy called tactical asset allocation. The idea for these funds is not just to invest in income-producing asset classes but to navigate among those classes to bolster returns. That said, SSgA's product is the only multi-asset ETF that is truly actively managed and trying to beat a benchmark. The others employ indexes that shift automatically based on yield and other criteria within specific sectors of income assets.

Under the Hood

The SSga ETF differs also by focusing on total return -- yield plus capital appreciation -- while the others primarily seek the highest payout. On the surface, the ETF looks simple. It has a 50 percent weighting of both stocks and bonds, around which Goolgasian and his team can shift as much as 20 percent in either direction. So the ETF could be invested as much as 70 percent in either stocks or bonds. During extreme market events, the managers have the freedom to go to 50 percent cash.

Under the hood, things get more complex. According to Goolgasian, that 50/50 benchmark weighting consists of 35 percent investment-grade bonds, 10 percent high-yield bonds, 10 percent hybrid securities such as preferred stocks and convertible bonds, 35 percent dividend-paying stocks and 10 percent real estate stocks. Within these categories, the ETF can invest in the U.S. or abroad.

Currently, Goolgasian favors dividend-paying stocks over bonds. He has an 18.6 percent position in SPDR S&P Dividend ETF and 11.5 in SPDR Barclays Capital Long Term Corporate Bond ETF. Because he believes long-term corporates will outperform Treasuries, he has only 7.3 percent of his portfolio in the SPDR Barclays Capital Long Term Treasury ETF.

Generating Income Creatively

Though the other four multi-asset income ETFs are indexed, with fixed allocations to asset classes, they're no less complex. The Arrow Dow Jones Global Yield ETF tracks the Dow Jones Global Composite Yield Index, which is made up of equally weighted positions in global equity, global real estate, master limited partnerships, global corporate debt and global sovereign debt. Within each category, Dow Jones screens for the 30 highest-yielding securities that meet certain credit, yield and liquidity requirements.

The Arrow ETF's goal is to deliver income and yield, rather than total return. So Arrow takes on greater credit risk and invests in more esoteric securities than SSgA. It owns master limited partnerships that own natural gas and oil pipelines, and it has 39 percent of assets in bonds rated below Standard & Poor’s investment grade of BBB, as well as corporate junk bonds and bonds from over-leveraged nations such as Portugal, Italy, Ireland, and Spain. Little wonder it yielded 6.6 percent after fees at the end of July; the SSgA ETF yielded 4 percent.

Equally complex, with a different risk profile, is the iShares Morningstar Multi-Asset Income Index Fund. It tracks a Morningstar index that is 60 percent bonds, 20 percent equity and 20 percent alternative assets such as preferred stocks and REITs. The heavier emphasis on bonds means it will be more sensitive to interest rates than the Arrow and State Street ETFs, but probably less volatile.

Then there’s the quirky Guggenheim Multi-Asset Income ETF. About 50 percent of its portfolio is in dividend-paying stocks, but the fund doesn’t own bonds directly. Rather, it invests part of the remaining 50 percent in closed-end funds, which are exchange-traded mutual funds that often hold bonds. It also owns real estate investment trusts, master limited partnerships and preferred stocks.

Not all financial advisers are skeptical of the ETFs. Brent Emerick, a Zionsville, Indiana-based financial planner, uses the Arrow Shares and State Street income ETFs for his clients. With interest rates so low, he figures the bond market is going to become much riskier. “We have to be a little bit more creative in finding places to generate income," he says. As for the risks of replacing bonds with things like MLPs and dividend-paying stocks, Emerick says he's more concerned about the income needs of retired clients in a market where 10-year Treasuries yield just 1.7 percent.

(Lewis Braham is a freelancer writer based in Pittsburgh.)

To contact the editor responsible for this story: Nikhil Hutheesing at

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