The 10 Best Income Plays for the Second Half of 2023

The 10 Best Income Plays for the Second Half of 2023


If you think you missed the stock market rally this year, think again. If income is your thing, the run may only be getting started.

Though the


S&P 500 index

has gained 15% this year, the rise has been driven higher by a narrow group of megacap tech stocks like



Apple

(ticker: AAPL),



Microsoft

(MSFT), and



Nvidia

(NVDA). Many industry groups that pay nice dividends are in the red, healthcare, electric utilities, banks, and consumer staples among them.

As a result, investors can now get 3% and 4% yields on a range of blue chips like



Exxon Mobil

(XOM),



Pfizer

(PFE),



Bank of America

(BAC), and



Coca-Cola

(KO), and 7% on higher-risk stocks like



AT&T

(T),



Verizon Communications

(VZ), and



Altria Group

(MO), the maker of Marlboro cigarettes. The rest of this year could belong to these sectors and stocks.

Dividend-paying stocks aren’t the only place to find income. Junk bonds yield 8%; preferred stocks, 6%; mortgage securities, 5%; and municipal bonds, 2% to 4%. Most sectors of the bond market have returned 3% to 4% this year—a respectable bounceback after a tough 2022, when there were double-digit losses.

Cash is also tempting, with risk-free U.S. Treasury bills yielding over 5%, comfortably above the inflation rate of 3% based on the past six months of consumer prices. That changes the investment calculus, with rates acting like gravity on returns, as Warren Buffett likes to say. But as attractive as cash remains, the odds are that a year from now, T-bill rates could be closer to 4%. This argues for some, but not total, exposure to cash.

All this suggests that investors shouldn’t give up on a traditional 60/40 mix of stocks and bonds. The poor 2022 returns for such an allocation don’t mean a lot now. It’s future returns that matter, and based on current prices, a 60/40 portfolio could generate mid- to high-single-digit returns going forward, particularly with dividend-paying stocks looking attractive and bond yields near their best levels in 15 years. Together, they could beat a lot of fancy, fee-heavy strategies used by endowments and pension funds that have large exposure to “alternative” assets like private equity.

There is no shortage of income in the stock and bond markets, and that’s a nice change from a few years ago. Here are 10 sources of investment income ordered from top to bottom in our estimate of their appeal.

Dividend Stocks

Fund / Ticker Yield YTD Return
Vanguard High Dividend Yield / VYM 3.4% -2.0%

Sources: Bloomberg; company reports

A simple strategy of owning high-dividend stocks has paid off over time, and it looks like a winning move now because it gives investors exposure to so many attractive out-of-favor sectors. The


Vanguard High Dividend Yield

exchange-traded fund (VYM), yielding 3.4%, and the


Schwab U.S. Dividend Equity

ETF (SCHD), at 3.7%, are two of the largest, with Exxon and



Johnson & Johnson

(JNJ) the top two holdings for the Vanguard fund, and



Broadcom

(AVGO) and



PepsiCo

(PEP) leading the Schwab fund.

Investors can find even higher yields overseas, where the average dividend yield is 2.6%, a percentage point higher than the S&P 500’s payout. The


Schwab International Dividend Equity

ETF (SCHY) yields 3.7%, with top holdings Italian utility



Enel

(ENLAY) and



Nintendo

(NTDOY). International markets have kept pace with the S&P 500 this year but have lagged badly behind in the past five and 10 years, potentially setting up for strong performance this decade.

Energy Pipelines

Fund / Ticker Yield YTD Return
Alerian MLP / AMLP 8.0% 6.3%

Sources: Bloomberg; company reports

Pipelines were once a tough sell but obsolescence fears have subsided as investors recognize the ongoing need for U.S. oil and gas. And with pipeline networks almost entirely built out, the companies won’t have to spend much beyond upkeep, resulting in ample free cash flow to support payouts.

And what payouts they are. Yields are now in the 5% to 9% range for industry leaders like



Williams

Cos. (WMB),



Kinder Morgan

(KMI)—both corporations—and



Enterprise Products Partners

(EPD) and



Energy Transfer

(ET), which are partnerships. The $6.4 billion


Alerian MLP

ETF (AMLP), meanwhile, yields 8%.

High free cash flow is also leading to more buybacks—formerly a rarity among pipelines—and the companies could capitalize on the energy transition by using their pipes to carry hydrogen or carbon dioxide, says Rob Thummel, portfolio manager of



Tortoise Energy Infrastructure

(TYG), a closed-end fund yielding 10%.

Utilities

Fund / Ticker Yield YTD Return
Utilities Select Sector SPDR / XLU 3.3% -6.8%

Sources: Bloomberg; company reports

This historically rate-sensitive sector has lagged this year despite strength in the bond market as investors shun traditionally defensive stocks. The


Utilities Select Sector SPDR

ETF (XLU) is down about 6% this year, while big utilities like



Duke Energy

(DUK) and



NextEra Energy

(NEE) have dropped 10% or more.

Investors should take advantage of the selloff. The outlook for utility earnings is probably the best it’s been in decades as the build-out of wind and solar power combined with the construction of new transmission lines should power steady profit gains.

“We expect utilities on average can deliver annual earnings and dividend growth in the 5% to 9% range,” says John Bartlett, portfolio co-manager of the


Reaves Utility Income

closed-end fund (UTG). Bartlett favors Michigan utilities



CMS Energy

(CMS) and



DTE Energy

(DTE), which both yield about 3.5%, because of the utility-friendly regulation of the state.

Mortgage-Backed Securities

Fund / Ticker Yield YTD Return
DoubleLine Total Return Bond / DLTNX 5.1% 2.9%

Sources: Bloomberg; company reports

This $8 trillion sector deserves more attention from investors because of its combination of historically attractive yields and high credit quality.

Yields are now in the 4.5% to 5.5% range, with benchmark mortgage issues from



Fannie Mae

and



Freddie Mac

offering a yield that is 1.75 percentage points above the 10-year Treasury note—about double the average spread over the past 20 years. The U.S. government controls Fannie and Freddie and likely will stand behind the companies in the unlikely event of a housing collapse.

“Mortgages are the cheapest part of the fixed-income market on a risk-adjusted basis,” DoubleLine Capital CEO Jeffrey Gundlach said on a recent investor call. His


DoubleLine Total Return

fund (DLTNX) is broadly focused on the mortgage sector. Also worth a look: the actively managed


Janus Henderson Mortgage-Backed Securities

ETF (JMBS), which has outpaced the passive


iShares MBS

(MBB) by about one percentage point a year in the past three years.

Real Estate Investment Trusts

Fund / Ticker Yield YTD Return
Vanguard Real Estate / VNQ 4.5% 1.7%

Sources: Bloomberg; company reports

There are plenty of concerns about commercial real estate, but the sector is up slightly this year after a terrible 2022, when the


Vanguard Real Estate

ETF (VNQ) was down 26%. Outside of offices, most sectors, including apartments, warehouses, and data centers, are in good shape.

As Barron’s cover story argues, there is value in REITs, with Green Street Advisors analyst Cedrik Lachance saying they are “a little cheap” versus the S&P 500. They look particularly good relative to private real estate funds, which haven’t adjusted nearly as much as public markets. “Investors don’t have to worry about lower private-market values because it’s already priced into public markets,” he says.

Lachance is partial to mall-industry leader



Simon Property Group

(SPG), which yields nearly 7%, due to its savvy management team. He also likes



Invitation Homes

(INVH) and



AMH

(AMH), which trade at a 15% discount to what he views as the value of their portfolios of single-family homes.

Junk Bonds

Fund / Ticker Yield YTD Return
iShares iBoxx $ High Yield Corporate Bond / HYG 8.0% 4.3%

Sources: Bloomberg; company reports

With recession concerns fading, junk bonds have generated decent returns this year with the


iShares iBoxx $ High Yield Corporate Bond

ETF (HYG) returning more than 4%. The second half looks just as promising. The yield on the key BofA index is an ample 8.75%, while the yield premium to U.S. Treasuries stands at 4.6 percentage points, in line with the historic average. Junk bonds are also safer than they have been historically: More than half the market is rated double-B, the highest junk rating category, and just 10% is in speculative



CCC

bonds.

“You’ve got a good shot at both price appreciation and income,” says Kevin Loome, manager of the


T. Rowe Price U.S. High Yield

fund (TUHYX), of the second half.

Loome likes the bonds of



Carnival

(CCL), the heavily indebted cruise-line leader that is seeing a surge in customers. Carnival’s six-year debt yields about 9% and offers a lower-risk alternative to the common stock.

Preferred Stocks

Fund / Ticker Yield YTD Return
iShares Preferred & Income Securities / PFF 6.5% 3.4%

Sources: Bloomberg; company reports

The failures of Silicon Valley Bank and First Republic Bank this year highlighted the risk in the bank-dominated preferred market. Both banks were preferred issuers and holders face a near-total loss on their investments. That’s the downside of preferreds, a senior form of equity, but equity nonetheless. When a bank fails, preferred holders generally fare no better than common shareholders.

Still, they have a lot to offer, particularly the preferred from big banks, with their financial strength and regulatory support.



JPMorgan Chase

(JPM) preferreds yield 5.5%; Bank of America’s (BAC) yield close to 6%; and



Wells Fargo
’s

(WFC) yield 6.25%. These payouts are about two percentage points more than the rate on the 30-year Treasury.

Preferreds aren’t just for banks. More speculative preferreds from New York office REITs Vornado Realty Trust (VNO) and



SL Green Realty

(SLG), both yield about 9%. The $13 billion


iShares Preferred & Income Securities

(PFF) now yields 6.5%.

Municipals

Fund / Ticker Yield YTD Return
Vanguard Intermediate-Term Tax-Exempt / VWITX 3.3% 2.4%

Sources: Bloomberg; company reports

The combination of tax-free income and relative safety has made munis the most popular bond investment for retail buyers. Yet the sector looks less appealing than it did a year ago.

AAA-rated 10-year munis, for instance, yield 2.5%, or two-thirds of the equivalent Treasury yield, down from 100% a year ago. That’s low by historical standards, and offers little benefit to muni holders after adjusting for taxes.

Long-term munis look better. Their yields roughly equal equivalent Treasuries, meaning a big after-tax yield advantage. Los Angeles airport bonds with double-A ratings yield about 4%, as do other high-quality long-term munis from essential-service entities.

The largest municipal-bond fund,


Vanguard Intermediate-Term Tax-Exempt

(VWITX), yields 3.3%, with a portfolio weighted to AA-rated bonds. Closed-end muni funds have been forced to cut their dividends due to higher rates, but trade at a large discount to net asset value. The largest, Nuveen AMT-Free Quality Municipal Income (NEA), yields 4%.

Convertibles

Fund / Ticker Yield YTD Return
SPDR Bloomberg Convertible Securities / CWB 2.4% 8.8%

Sources: Bloomberg; company reports

The hybrid securities have had a good 2023, with the


SPDR Bloomberg Convertible Securities

ETF (



CWB

) up over 8%. Converts usually carry low yields—the Bloomberg fund yields just 2.5%—but offer an equity kicker because they can be swapped for common shares if the stocks appreciate.

This year’s appreciation in the $235 billion market reflects a high weighting in tech stocks as well as a rally in such sectors as cruise lines, with Carnival and



Royal Caribbean Group

(RCL) sizable issuers. Michael Youngworth, a convertibles analyst at BofA Securities, sees a more muted second half due to elevated tech valuations. Issuance has picked up to $26 billion so far this year, three times the 2022 pace, he says.

Looking for higher yields? Riskier “busted” convertibles from the likes of



Coinbase Global

(COIN) and



MicroStrategy

(MSTR) act like regular bonds and yield over 10%.

Treasuries

Fund / Ticker Yield YTD Return
iShares 20+ Year Treasury Bond / TLT 3.8% 5.4%

Sources: Bloomberg; company reports

Treasuries have a lot to offer, whether investors want to stay short or go long.

While short-term T-bills offer yields of 5%, they’re unlikely to drop below 3%, and returns could exceed the inflation rate. The 10-year note locks the rate in but loses value if yields rise.

ETFs offer a good alternative because they offer easy liquidity and can be bought and sold like stocks.


SPDR Bloomberg 1-3 Month T-Bill

(BIL) yields about 5%, while


iShares 1-3 Year Treasury Bond

(SHY) yields more than 4.5%. The longer-term


iShares 20+ Year Treasury Bond

(TLT) yields about 4%.

Treasury inflation-protected securities, or TIPS, offer inflation-adjusted yields in the range of 1.5% to 2%, high relative to the 15-year average. The


iShares TIPS Bond

(TIP) ETF and the shorter-maturity


iShares 0-5 Year TIPS Bond

(STIP) are solid choices.

Write to Andrew Bary at [email protected]



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