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ETF Specialist

ETFs with High Yields to Help You Sleep at Night

In the search for sustainable yields, it's critical to look under the hood of your ETF.

Financial markets around the globe are fluctuating violently due to greed and fear--with fear overshadowing occasional glimpses of optimism over the past few months. Amid the unprecedented levels of volatility we are experiencing in the market today, it's no surprise that many investors are clamoring for some sort of stability, or a financial "safety-net," if you will. To that end, we decided to dig through our database of more than 800 ETFs in search of the highest-yielding funds. If we are facing a period during which investors should expect lower returns due to the deleveraging process our financial system is--and will continue to--undergo, as well as the looming threat of a global slowdown, then sustainable dividend payments could be an excellent way to ensure we're capturing our fair share of the market's returns.

At  Berkshire Hathaway's (BRK.B) shareholder meeting in May, CEO Warren Buffett made it very clear that he's ratcheted down his expectation for future returns on publicly traded stocks. When asked about his outlook for expected returns on Berkshire's stock portfolio, Buffett promptly replied, "We would be very happy if we earned 10%, pretax." Cochairman Charlie Munger added, "You can take what Warren said to the bank. We are very happy at making money at a rate in the future that's much less than the past�and I suggest that you adopt the same attitude." Keep in mind that these are two of the greatest investing minds of our time, if not in history.

So, if we can uncover a few ETFs offering midsingle-digit yields that we think are sustainable, then we've taken care of half the battle. The key word here is "sustainable." We're interested in uncovering only those ETFs that offer reliable dividend payments. The goal is to sidestep those ETFs that, on the surface, appear to offer some very handsome yields, but could see dividend payments slashed in lieu of raising or preserving capital in an attempt to survive the ongoing credit crunch. The financial-services sector is home to several companies that have seen their yields shoot through the roof as their stock prices have plunged.

Yield-hungry investors who rushed into the financial sector in an effort to capitalize on some eye-popping dividend yields were sorely disappointed when the parade of dividend cuts, suspensions, and eliminations ensued. Even the venerable  Bank of America (BAC), which many have deemed to be one of the major beneficiaries of the shakeout in financials, announced a 50% cut to its dividend and massive capital raise following its disappointing third-quarter results. To avoid subjecting ourselves to a similar fate (i.e. high probabilities of dividend cuts given the fragile state of the sector and the need for precious capital), we screened our database of ETFs with a discerning eye on a given fund's exposure to the financial-services sector. We also limited our search to U.S. equity ETFs, excluding some high-yielding preferred stock issues, fixed-income ETFs, currency funds, and REIT portfolios. Notice in the table below that four out of the five ETFs offering the highest yields court "overweight" exposure to the distressed financial sector.

 Highest Yields Regardless of Exposure
 
Net Assets YTD %
Return
12-
Month
Yield
Financial
Services %
Expense
Ratio
Inception
Date
Claymore/BBD High Income  5,921,795.00 -40.15 11.21 30.63 1.54 06/25/07
Market Vectors Nuclear Energy ETF (NLR) 176,375,058.00 -54.97 8.66 0.00 0.65 08/13/07
PowerShares Listed Private Equity (PSP) 117,238,057.00 -40.85 8.23 79.01 0.71 10/24/06
iShares S&P Global Financials (IXG) 271,402,698.00 -43.25 7.62 97.71 0.48 11/12/01
Claymore/Zacks Yield Hog (CVY) 45,755,681.00 -36.13 7.61 36.73 0.79 09/21/06

Though the Federal government is working tirelessly to stop the bleeding in the financial sector and create an environment where banks will once again extend credit, there's still far too much uncertainty in the sector for our taste. Thus, we narrowed our search by selecting only those ETFs that have minimal exposure to financials. The table below highlights those non-financial sector ETFs that are sporting attractive yields. We think this list is a much better place for yield-seeking investors to begin their hunt, as the ETFs included provide more dependable income streams.

 High-Yielding ETFs with Minimal Financial Exposure
 
Net Assets YTD %
Return
12-
Month
Yield
Financial
Services %
Expense
Ratio
Inception
Date
Market Vectors Nuclear Energy ETF (NLR) 176,375,058.00 -54.97 8.66 0.00 0.65 08/13/07
First Trust Utilities AlphaDEX (FXU) 14,314,869.00 -34.79 6.04 0.00 0.70 05/08/07
Claymore/SWM Canadian Energy Income  25,628,672.00 -51.10 5.89 0.00 0.83 07/03/07
iShares S&P Global Telecommunications (IXP) 227,421,811.00 -38.09 5.45 0.85 0.48 11/12/01
PowerShares Dynamic Leisure&Entertain (PEJ) 12,172,136.00 -39.48 5.07 0.00 0.63 06/23/05
Rydex S&P Pure Value (RPV) 21,982,082.00 -43.13 4.51 28.69 0.35 03/01/06
Vanguard Telecom Services ETF (VOX) 106,914,948.00 -44.10 3.74 0.00 0.23 09/23/04
Vanguard High Dividend Yield Index ETF (VYM) 138,458,830.00 -32.31 3.72 20.55 0.25 11/10/06
WisdomTree Total Dividend (DTD) 87,426,318.00 -34.35 3.71 29.08 0.28 06/16/06

Note that utility companies are prominent here (particularly in the Market Vectors Nuclear Energy ETF (NLR) and the First Trust Utilities AlphaDEX (FXU)). We understand that some investors seeking significant capital appreciation may want to avoid the steady-as-she-goes utility sector. Consequently, we decided to tack on a few extra names to the table above.

The bottom line for investors is to make sure to understand what's beneath the hood of a given ETF before taking the plunge. With fear taking center stage in the current environment, there are certainly plenty of wonderful opportunities to be taken advantage of by thoughtful investors. Aside from the troubled financial sector, investors may also wish to avoid deeply cyclical companies--whether tied to the business cycle, commodity prices, or discretionary consumer spending--as they just aren't as good at paying the reliable and rising dividends many investors are seeking. The name of the game is sustainability. After all, dividend cuts are dire signals of financial distress, materially eroded earning power, or both. Therefore, we urge investors seeking yield in the current environment to look under the hood and make sure to be comfortable with the businesses included in a given ETF's portfolio. And remember, if it sounds too good to be true, then it probably is.

 

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