How to reach for yield with limited risk

If you’re going to over-indulge in any single type of investment or economic sector, high-quality utility stocks are your best choice for doing so.

fortis_inc

Fortis has investments in electric utilities in Newfoundland, Alberta, BC, PEI, Ontario, nine US states and three Caribbean countries.

Many income-seeking investors have grown almost despondent over today’s low interest rates. This despondency, in turn, can lead to an unhealthy fixation on current income which then leads on to ‘reaching for yield’, as it’s called in the jargon of the trade: the willingness to accept greater risk in return for more income. Just keep in mind, however, that reaching for yield can cost you a lot of money.

Mind you, it’s possible to invest for yield without really reaching too far. Recently, for instance, a friend asked our views on loading up his portfolio with utility stocks. Some of his higher-rate long-term bonds are now maturing. Meantime, he’s not particularly comfortable with most income trusts. Only utility stocks offer the high yields he feels he needs. He’s tempted to replace his maturing bonds entirely with blue chip utility stocks, even though this means he’ll have shifted a much larger proportion of his portfolio out of fixed-return investments and into stocks.

Generally, we think you’re better off with a balanced, diversified portfolio, even if it means giving up some yield. We think it’s best to keep each of the five economic sectors (utilities, finance, consumer, resources and manufacturing) under, say, 30 per cent of your portfolio. On the other hand, many of the utilities on our Key stocks list serve growing markets and are using their expertise to expand both at home and abroad. They may have little-recognized growth potential, along with above-average yield.

Fortis offers a safe way to reach for yield

Consider, for example, St. John’s-based Fortis Inc. (TSX—FTS). It has diversified and now has investments in five electricity utilities in Newfoundland and Labrador, Alberta, BC, Prince Edward Island and Ontario. Fortis also operates utilities in nine American states and three Caribbean countries. This diversification reduces its risk from natural disasters and by regulator. As its profits have increased, Fortis has raised its dividends for 29 years. It remains the king of Canadian dividend aristocrats.

If you decide to push utilities to 40 per cent or even half of your portfolio, however, you should compensate for this strategy by cutting your risk by diversifying within the utilities sector. You’d want to spread your funds out among gas and electricity distributors, pipelines and phone stocks. Your utility stocks would suffer if interest rates shoot up—but, then again, so would almost anything else. In that unlikely event, most utilities on our Key Stocks list would still be able to maintain their dividends. If interest rates go high in the future, regulators would eventually let utilities raise their rates.

In short, if you’re going to over-indulge in any single type of investment or economic sector, high-quality utility stocks are your best choice for doing so.

By contrast, over-indulging in derivatives, especially options, is probably the worst form of over-indulgence. For instance, you might sell calls on your stocks (giving the buyer the right but not the obligation to buy your shares at a fixed price, for a fixed period). This gives you higher current income, even after you pay fees. It also guarantees you’ll sell all your winners, and hold on to your losers. In our experience, this is certain to cost you money, in the long run if not in the short.

This is an edited version of an article that was originally published for subscribers in the October 16, 2020, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.

The Investment Reporter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846

Comments are closed.