Goldman's Preferred Shares
I have liked Goldman Sachs (NYSE:GS) series A preferred shares (GS.A) for a long time. These notes are perpetual floating rate instruments that pay a dividend equal to the three-month Libor plus 75 basis points. The great thing about them is that they have a dividend floor of 3.75% and they trade at 78% of their $25 face value. Hence, they offer a current yield of 4.75%.
Moreover, they also offer a hedge against the eventual (and unavoidable) raise in U.S. interest rates through their floating dividend tied to the Libor rate. The price of this preferred shares has been somewhat stable throughout the year and they pay their dividends quarterly on the 10th of February, May, August and November.
Going Back to Basic ETFs
ETFs can be a great way to diversify your holdings in a cheap way. Even when rates are poised to rise in the U.S., companies are also poised to default less as the economy ameliorates. With this in mind, an ETF that is composed of U.S. high-yield corporate bonds could be a feasible alternative to stocks at the current valuation level.
My favorite ETF within U.S. high-yield space is the iShares Iboxx Corporate Bond ETF (HYG) which is held by John Keeley and John Burbank. IShares's ETF, which is composed by over 850 holdings, has a distribution yield of 6.24%, an effective duration of 4.25 years and an expense ratio of 0.50%.
Another similar alternative, which at the current market prices is slightly cheaper is the SPDR Barclays High Yield Bond ETF (JNK). While the iShares ETF trades at a 0.24% premium, the Barclays ETF trades at a 0.13% premium to the fund's net asset value. The Barclays ETF has a current yield of 7.08%, an average effective duration of 4.43 years and an expense ratio of 0.40%.
Despite a narrower amount of holdings (663 versus 853), given current market prices, I would rather own the ETF from Barclays. That said, both should perform relatively in the same way. The key parameter here is not only the current yield offered by the instruments but also their short effective duration. As interest rates increase, longer duration instruments should suffer the most.
As Buffett said, as market prices keep on soaring, every day it's tougher to find cheap things to buy. On the other hand, when you pay higher prices your margin of safety narrows and your risk increases in an equal amount. These are three viable alternatives to park your money in until new good equity ideas appear in your investment horizon. I am not saying the market is expensive but it is not as cheap as it used to be a year ago. Always keep in mind, “Value is what you get and price is what you pay.”