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    March 2013
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    In Search of Higher Yields

    Guy Conger

    As interest rates have fallen to record lows and
    stayed there in recent years, the yield on your
    savings may be stuck in neutral. If you’ve
    focused on capital preservation and kept your
    assets in U.S. Treasuries, a money market
    account, or certificates of deposit, you may
    have minimized the chance of the financial
    equivalent of a car crash. However, you also
    may not be happy letting your portfolio’s engine
    idle forever.
    Dividend-paying stocks are one solution, but
    last year’s volatility has made many investors
    wary of committing more money to equities.
    Though past performance is no guarantee of
    future results, for those who need something
    more than 2% 10-year (US) Treasury yields and who
    can handle the additional risks involved, there
    are other alternatives that could potentially
    boost overall yield.
    Corporate bonds
    Many corporations have taken the opportunity
    presented by low rates to refinance their
    corporate debt and lower borrowing costs.
    Though any company could still default on its
    obligations, of course, and all bonds face
    market risk, stronger balance sheets have
    helped lower the overall risk of corporates as a
    whole. The spread between the yield on
    Moody’s Aaa-rated industrial bonds and
    10-year (US) Treasuries at the end of 2012 was
    roughly 1.7 percentage points. For a Baa bond
    (one notch above noninvestment-grade), the
    difference was over 3 percentage points. Yields
    on noninvestment-grade bonds (so-called
    high-yield or “junk” bonds) were higher still,
    roughly 5% above 10-year (US) Treasuries.
    Bank loans
    Floating-rate bank loans (also known as senior
    loans, leveraged loans, or senior secured
    loans) are a form of short-term financing for
    companies that usually do not rate an
    investment-grade credit rating. The rate is
    typically tied to the London Interbank Offered
    Rate (LIBOR) and adjusts with it, generally
    quarterly. As with high-yield bonds, the lack of
    an investment-grade credit rating means bank
    loans must offer a higher yield.
    As with all debt, investors still run the risk of
    default. However, bank loans also have
    benefitted from the favorable corporate finance
    picture noted above. And because bank loans
    typically are a company’s most senior debt
    obligation and are secured by some form of
    collateral, investors have typically recovered a
    higher percentage of their investment in the
    event of default than with high-yield bonds
    secured only by a company’s promise to pay.
    Finally, as with all bonds, as bond yields rise,
    the price falls, which could cut overall return
    enough to offset any yield advantage. For the
    majority of investors, the most accessible way
    to invest in floating-rate bank loans is through a
    mutual fund or exchange-traded fund.
    Master limited partnerships
    Master limited partnerships (MLPs) can not only
    offer an income stream in the form of quarterly
    cash distributions; they also may offer tax
    benefits. An MLP that receives 90% of its
    income from qualified passive sources such as
    oil, natural gas, real estate, or commodities
    may qualify for tax treatment as a partnership
    rather than a corporation. If it does so, the MLP
    is not taxed at the partnership level, and may
    pass on a greater share of its earnings to the
    limited partners (i.e., individual investors), who
    also receive a proportionate share of any
    depreciation, depletion allowances, tax credits,
    and other tax deductions.
    Many MLPs are managed so as to ensure that
    those tax benefits offset or eliminate any
    current tax liability on the cash distributions,
    which are considered a return of capital and
    used to adjust the individual partner’s cost basis
    upon sale of the MLP units. An MLP that
    pursues this strategy successfully can in effect
    provide a tax-deferred ongoing income stream,
    which can be particularly appealing to investors
    in a high income tax bracket. Yields on MLPs
    vary greatly, depending on the particular MLP’s
    assets and the way in which the general partner
    manages the business.
    MLPs have risks. Because they can be
    relatively illiquid, an investor should plan to stay
    invested for a number of years, and individual
    investors’ collective share of cash distributions
    may decrease over time. Also, the tax issues
    involved can be complex; for example, MLPs
    can create problems if held in a tax-deferred
    retirement account. Finally, commissions and
    other front-end costs can reduce the amount
    available for investment.

    The MONEY® Network