To get double-digit yields today, you’ll have to invest in the kinds of publicly traded stocks that rarely come up in cocktail-party conversation: mortgage REITs and business development companies. Both borrow at low short-term interest rates and lend at higher long-term rates, so their success depends on the Federal Reserve keeping short-term rates low. If short-term rates start to climb, shares of both mortgage REITs and BDCs are likely to tumble.
Analyst Merrill Ross, of Wunderlich Securities, in Memphis, Tenn., recommends Invesco Mortgage Capital (IVR, $22, 12.0%). Run by an affiliate of the Invesco mutual fund group, the REIT owns residential and commercial mortgages. About 70% of its investments are “agency” loans, those backed by the likes of the Government National Mortgage Association. A relatively high 17% of the portfolio is in higher-yielding but riskier non-agency loans, though rising property values mitigate some of the danger.
Jason Stewart, head of research at Compass Point Investments, a Washington, D.C., firm, likes AG Mortgage Investment Trust (MITT, $25, 13.0%), in part because 18% of its portfolio’s assets are in non-agency loans. Stewart is also high on AG’s execs; they’re affiliated with hedge fund operator Angelo, Gordon & Co., which has a superior record. For more diversification, pick between two ETFs that specialize in this group: iShares Mortgage REIT Capped ETF (REM, 11.1%) and Market Vectors Mortgage REIT Income ETF (MORT, 10.2%).
Business development companies may be esoteric, but they are hardly undiscovered. The stocks have been sizzling of late, so it has become tougher to find attractively priced high yielders, says analyst Greg Mason, of Keefe, Bruyette & Woods. One BDC that does pass muster with Mason is KCAP Financial (KCAP, $10, 11.0%), which specializes in some of the riskier pockets of the lending market. The New York City firm’s loan portfolio is filled with high-risk, high-return loans. But Mason says KCAP’s executives are highly skilled and will likely minimize defaults.
Some leveraged closed-end muni bond funds also scale to 10%-plus heights. Like the block of BlackRock funds mentioned earlier, these four Invesco funds—Advantage Municipal Income Trust II (VKI, $13, 6.6%), Municipal Opportunity Trust (VMO, $15, 6.6%), Municipal Trust (VKQ, $14, 6.4%) and Trust for Investment Grade Municipals (VGM, $15, 6.6%)—employ similar strategies, only they do so with tax-free debt. The funds invest mainly in long-term high-quality bonds that finance such things as airports and hospitals. For investors in the top 39.6% bracket, a tax-free yield of 6.6% is equivalent to 10.9% from a taxable investment. All four funds recently traded at small discounts to NAV.
If you’re willing to go for broke to earn the best yields, consider Northern Tier Energy (NTI, $27, 20.6%). The Ridgefield, Conn.–based pipeline and refining firm has made only two distributions since going public last year, so the yield is based on what’s been paid so far. If Northern Tier’s profits keep rising, as analysts expect, it will continue to make rich distributions. But commodity prices are volatile, so profits, payouts and the share price could be, too.