3 ways to handle excessive yield investments as rates of interest rise

High yield, low visibility.

So many investors see high dividend stocks these days as interest rates rise and the US economy shows signs of recovery.

Historically, high yield investments tended to outperform the S&P 500 in the three years following a recession, Isaac Braley, president of BTS Asset Management, told CNBC’s “ETF Edge” this week.

But investors have piled into the room for the past few years amid a market-wide hunt for returns, “giving money to this asset class in hopes that it will make a difference,” Braley said in an interview Monday.

“Last year it didn’t even cover its earnings, so there are pent-up opportunities in many of these different areas,” he said.

One such area could be the energy sector, Braley said, noting that oil companies typically need crude oil prices above $ 50 a barrel to be profitable and now above $ 60.

“With last year’s outages, so many … energy companies wouldn’t buy the lease or equipment of a failing company. Today they can,” he said. “There are still companies that are unable to cover the costs and that will go under, but others can fill in. That will drive recovery rates up. That will help the markets.”

“Zombie companies” or highly indebted companies that continue to operate despite being unable to meet their debt obligations are still a challenge in the high yield space, Braley warned.

“You get free access to debt, you can extend debt at these very, very low interest rates, but will you be able to make profits that can cover them?” he said. “That’s the challenge in the short term, and that’s why the high returns here have really … flattened out for a while as they try to see what is really about the economy. Stocks can jump into the future very easily, but they have high returns a due date associated with them. They can’t. “

Even so, “the overall quality of the universe has improved,” said Stephen Laipply, managing director and head of US iShares fixed income strategy at BlackRock, in the same “ETF Edge” interview.

Over the past 10 to 15 years, the number of BB-rated investments has increased from around a third of the high-yield market to around 50%, while CCC-rated investments have fallen from around 20% to the low teens, Laipply said.

“The general health of the universe has improved over time,” he said. “Upgrades are currently outperforming downgrades on high returns. We are currently seeing improvements in fundamentals in terms of interest coverage, and even the recovery is starting to improve. If you were thinking about this long-term income transfer trade, you did so to believe the Current stimulus measures will result in longer term economic growth and that these fundamentals will persist and allow you to continue that income. “

Assuming government bond yields continue to climb gradually, yields on high dividend investments should also increase, said Laipply, whose company runs the popular iShares iBoxx $ High Yield Corporate Bond ETF (HYG).

Those looking for the best rate of return per unit of risk may want to steer clear of the high-yield space altogether, said John Davi, chief investment officer and founder of Astoria Portfolio Advisors, in the same interview.

“They all have drawbacks but not many advantages. So you will never convince me that you are better off owning high-yield credit than high-dividend stocks or an ETF,” Davi said.

He noted that the SPDR S&P Dividend ETF (SDY) has achieved double HYG’s average annual growth over the past decade, despite a slightly higher risk profile.

“I just think there are better places to put your money,” said Davi. “Our big view … is that 10 years is going a lot higher. I think it’s going to be closer to 3% where this thing is going. We just print money and there’s only a ton of supply out there and I don’t. ” I don’t see anyone step in and buy these bonds. “