Financial "mad scientists" always mix ingredients and styles to develop the ultimate investing tool.
These mission-obsessed types will stop at nothing in their quest for profitable investments. No matter how complex an idea, there is someone, somewhere distilling it down into a tradable instrument. This innovation is particularly noticeable in the world of exchange-traded funds (ETFs).
ETFs have become extremely popular in recent years. Generally designed to target a particular market niche, ETFs have opened up a world of opportunity for the everyday investor. Never before has it been so easy to access any asset class or investment theme through a single instrument traded like a stock on the exchange.
The latest mad-scientist ETF creation is based on multiple asset classes and is designed to create yield.
Rather than drill down into a particular niche like traditional ETFs, the multi-asset ETFs seek diversification of asset classes with yield being the only commonality. They are designed to provide diversified exposure to yield in a more stable instrument than could be accessed by investing in single high-yielding financials.
Launched in 2012, the multi-asset ETFs have the same stated goals: high-income, long-term appreciation and preservation of principal through diversification and lower volatility. Interest rate risk of bonds, market sensitivity and credit risk of high-yield bonds are mitigated by the diversified mixture the ETF is built upon.
As with any investment, risk equals reward. Although some of the risk is lessened by the diversified nature of the ETFs, the yield earned by these multi-asset ETFs is directly related to the riskiness of the underlying asset mix.
Here are three multi-asset ETFs divided into low-, medium- and high-risk categories.
1. Low risk/low reward
The iShares Morningstar Multi Asset Income Fund (NYSE:IYLD) is the least risky of these multi-asset ETFs because of its 60% allocation into fixed-income securities. The ETF is designed to follow the Morningstar Multi-Asset High Income Index. It has about 20% in a high-yield bond ETF to give it some kick over the fixed-income portion. It has 10% allocated to preferred stocks, 11% to emerging market bonds and 15% to long-term treasuries. It yields a little less than 2%.
2. Medium risk/medium reward
The First Trust Multi-Asset Diversified Income Index Fund (MDIV) seeks to do exactly what its mouthful of a name suggests.
It earns dividend income through a basket of diversified multi-assets. The ETF follows the Nasdaq Multi-Asset Diversified Income Index.
Its underlying assets include 25% in common stocks, 20% in real estate through real estate investment trusts (REITs), 20% in preferred stocks, 20% in master limited partnerships (MLPs) and 15% in an ETF based on the above Nasdaq index. It rebalances this mix quarterly and has a 0.60% expense ratio.
If you follow Carla Pasternak's High-Yield Investing newsletter, then you are already familiar with some of the underlying names in this multi-asset ETF. The ETF holds 124 assets with iShares i Boxx $ High Yield Corporate Bond (HYG) at 15%, American Capital Agency Corp (AGNC) at 2.2% and Two Harbors Investment Group (TWO) at 1.9%. This ETF is new but is producing an annual yield of 6.33%.
3. High risk/high reward
The Arrow Dow Jones Global Yield ETF (GYLD) is for investors who don't mind embracing risk in search of high yield. It is designed to track an index built from equally weighted sub indexes of five different asset classes: global real estate, global equity, global corporate debt, global sovereign debt and global alternative.
Each sub index is comprised of 30 equally weighted securities chosen for yield. Boasting a nearly 9% annual yield minus the hefty 0.75% expense ratio, this ETF is perfect for high-yield, risk-taking investors. Its allocations include 60% in foreign securities and 40% in fixed-income, non-investment grade bonds.
Risks to Consider: Multi-asset ETFs are very new and thus untested. Although the underlying idea is solid, more history is needed to determine how they react in different market environments. In addition, there may be tax ramifications or benefits due to the MLP component and mixture of asset classes.
Action to Take --> I really like the idea of the multi-asset ETFs as an additional way to diversify a portfolio. These ideas have been available as separately managed accounts for institutions and high net-worth individuals in the past, but this is the first time every investor can access this style of yield-earning diversification. Depending on your risk temperament, one of the three listed ETFs could make a positive addition to your stock portfolio.
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