August 2017 Investing for Income: PREFERRED INVESTOR ...

Investing for Income August2017

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Strategies to Boost Your Cash Yield

Unless otherwise noted, all prices are current as of July 14, 2017. Subscribe to Kiplinger's Investing for Income for more timely rates and yields in every monthly issue.

Timeless Tips for Successful Income Investing

Treasury and other interest rates have edged up over the last few months, shaving the market value of bonds and bond funds. At the same time, money is storming into stocks, sending the familiar market averages to records and plenty of individual shares so high you might think their prices are optical illusions. Bullish economic forecasts are everywhere. This might tell you that now is the time to turn your back on income and go all-out for capital gains.

We disagree--and not only because we figure that if you're reading this, you're eager for fresh ideas and insights about dividends and interest. Since we introduced this letter in 2012, we've consistently--and accurately-- advised that if you scatter your savings around various kinds of bonds and stocks and include "pass-through" securities including real estate investment trusts and infrastructure partnerships, the winners' returns will offset, and usually exceed, any principal losses. At the same time, you'll collect steady and often rising income. This is true whether the occasional setbacks result from higher interest rates, traders' panicky pessimism, or real business weakness such as that which led to cuts in some oil and gas dividends when a barrel of oil sold for less than $30 back in 2016.

But such downturns tend to be transitory. We've seen for years trading in reaction to

headlines saves little principal but frequently costs essential investment income. That's

The golden rule of income investing is

to be sure that you will get paid.

why the best bond portfolio managers do not trade on dayto-day interest-rate forecasts and movements. It's also why Kiplinger's Investing for Income takes a long view and rarely replaces the names or the sectors in our interest-and-dividendoriented model portfolios.

Despite persistent low yields, we are not opposed to moneymarket funds, bank deposits and short-term Treasury debt. If you

have money earmarked for a purpose with a nearing deadline, such as buying a vacation home this winter, you shouldn't take much risk with it. But when you need investment income to supplement your cash flow, there are far, far better options that pay well, are fully liquid, and are not restricted to extremely wealthy or institutional investors. The following core principles are serving you well in 2017, as they have in previous years.

Cash flow is king. The golden rule of income investing is to be sure that you will get paid. Sure, a company might be unable to sustain its dividends if it reports a loss or an energy partnership could slash its payout because of turbulent oil and gas markets. But enterprises whose primary appeal

continued on next page ...

Inside This Issue...

Unless otherwise noted, prices and data are as of July 14, 2017

Yieldcos Power Up With a Second Wind

3

These high-paying investments in

alternative energy generation are

coming into their own.

Standing Ovation for the Green Swans

4

How's our low-risk, high-dividend

stock portfolio faring? Very well, and

we're happy to tell you why.

Timely Tactic of the Month

4

Yields are looking good on two- and

three-year corporate notes.

Kiplinger's 25 for Income

5

A strong month, led by utilities and real

estate. One member hits a four-year high.

Ask Jeff

6

Questions about ETFs, a shopping-center

REIT, Annaly preferred shares, and the

relationship of junk bonds to stock prices.

What's New in Cash

7

Los Angeles gets upgraded while

Standard & Poor's keeps the Treasury's

rating down. And the return of

non-traded REITs.

Rates and Yields

7

Model Portfolios

8

The latest on our four rotating models:

Dividend-A-Month, Juiced-Up Cash,

Going for the Max, and Tax-Exempt Income.

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Investing for Income: Strategies to Boost Your Cash Yield

August 2017

... continued from previous page

to the investing public is monthly or quarterly cash disbursements normally have sufficient cash flow, and some money in reserve, to meet obligations. You can judge this--as we do in our research-- with the aid of the cash flow and operations sections of the issuer's financial statements. Cash flow, along with money in reserve, should comfortably exceed the promised income distributions most or all of the time. An occasional stumble is acceptable. But we steer clear if a company or fund must regularly engineer big capital gains or borrow or sell new shares to fund dividends.

Maximize your after-tax income. You know municipal bond interest is generally taxfree (though some muni interest falls victim to the federal Alternative Minimum Tax and a some states tax out-of-state bond interest). But there are other tax-advantaged investments where the source, such as a REIT, either isn't taxed on its own earnings or that hold down

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your tax bill because part or all the funds that flow your way is a long-term capital gain or a return of capital. Even when you pay ordinary income tax rates, you might benefit from a tax break that applies at the corporate or fund level. And common and preferred stock dividends are often "qualified," meaning your maximum federal bite ranges from 0% to 23.6%, not the 10% to 43.4% span that applies to ordinary income. In all, a widely-diversified income portfolio shouldn't give you tax nightmares.

Get to know closed-end funds. These are complex investments with many moving parts. Sometimes, the costs are high. But CEFs are superb income sources because many employ leverage, borrowing at low interest rates to purchase topquality stocks and bonds. Plus, their managers' daily investment routine isn't disturbed by cash inflows and outflows as it often is with ETFs and traditional mutual funds. Best of all, you can frequently buy closed-end fund shares below net asset value and thereby acquire an interest in every $1 of portfolio assets for 90 or 95 cents.

It is okay to reach for yield since you are not alone. It's rare to find a popular investment guide that respects high yields. Instead you often read that you're asking to get clobbered if you choose investments with aboveaverage yields. Sometimes, that is true. But since 2008 savers and investors in all income brackets have been eager to buy--and keep--strong income-payers with a growth element: junk-bond funds, utility stocks, pipeline partnerships and REITs come

to mind. We detect a significant comfort level now that may be tested, but will not vanish. Obviously, if your bank offered 8% on a CD while a junk-bond fund paid 6%, you'd be smart to switch to the bank. But then so would everyone else. Until then, there's safety in numbers in the quest for a reasonable yield.

Basic energy still matters. Despite the energy bust of 20152016, it would be a mistake to ignore oil and gas and all the efforts to process and transport it from its raw state to your car and your furnace. One of the arts of investing for income is to spot where money is moving and how best to tap into such commerce at the safest stages. That's why pipeline and storage partnerships and other "midstream" and "downstream" energy investments have recovered smartly from the slump. These busy enterprises pay reliable dividends regardless of prices at the wellhead.

Finally, a magic number for you. It is 25, as in $25. That's the original (par) value of most preferred stocks and bond snippets, our name for exchangetraded bonds or "baby bonds." If you spot any under $25, you're almost guaranteed a profit unless the issuer defaults, which isn't as common a threat as you might think. The trick is to be patient and watch for your chance to buy below par. For example, in July you could find several preferred stock classes from BB&T, an extremely sound regional bank, for just about $25, a current yield of 5% to 5.5%. BB&T's common shares pay a 2.6% dividend. Plus, preferred stockholders and bondholders must be paid before the common shareholders get a cent.

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August 2017

Investing for Income: Strategies to Boost Your Cash Yield

3

Yieldcos Power Up With a Second Wind

In 2015, we were hopeful, although cautious, about a newfangled energy investment called a yieldco. A yieldco buys wind, solar and hydropower farms and plants as they are spun off from independent power producers. The lure to investors is income comparable to that from junk bonds and preferred stocks, plus the potential for dividend growth. Yieldcos also enjoy various tax breaks.

But just as interest was building in these investments, the combination of falling energy prices and an oversaturation of initial public offerings prompted investors to flip off the switch. Yieldco share prices dropped by half in mid and late 2015. Cash flows stayed strong, though, and now investors are back, in the same way they have returned to the master limited partnerships whose units traced a similar roller-coaster pattern. In the first months of 2017, big yieldcos such as Atlantica Yield, NRG Yield and Pattern Energy Group have already returned between 10% and 35% and are yielding 5% or more.

What's next? Restraint rather than irrational exuberance, says Garvin Jabusch, chief investment officer of Green Alpha Advisors, in Boulder, Colo., which specializes in the group. He's convinced that renewable-energy suppliers, conscious of not repeating the mini bubble of 2015, are eyeing more-stable new offerings. "They'll launch them when they have quality projects that can offer good yield, good fundamentals and the ability to provide dividend growth in the future." Jabusch notes that in 2016, 65%

of new U.S. generating capacity came from either wind or solar. "Renewables are outpacing gas development two to one, and as that continues, a lot of that generation will be owned by yieldcos," he says. His view is tempered, though, by the possibility that rising credit costs will undermine the profitability of new projects.

Besides an expanding market, yieldcos have another advantage: insider-ship. It is common for a yieldco to have

Share prices lost 50% in 2015, but cash flow

remained strong and now investors are back.

an agreement called a right of first offer, or ROFO. It gives the yieldco the right to acquire the most-profitable projects in the sponsor's portfolio and the authority to reject potentially dismal deals. Such agreements ensure that yieldcos are not a dumping ground for second-rate assets, as is sometimes the case with publicly traded spinoffs of famous private-equity firms and hedge funds. "Understand the portfolios the yieldco owns today, the risks associated with the types of power production, the management team and the ROFO pipeline, because that's what will determine its future growth," says Martin Wildy, who manages Eventide Multi-Asset Income Fund (symbol ETAMX), which has 13.0% in yieldcos and a 9.1%

year-to-date return. The following six yieldcos deserve a look.

Our 2015 picks... Atlantica Yield (ABY, $20,

5.1% yield, year-to-date total return 7.5%, three-year dividend growth rate NA). Formerly Abengoa Yield, this diversified yieldco owns 22 assets in the U.S., Canada, Latin America and Europe.

NRG Yield (NYLD-A, $17, 6.8%, 16.1%, 16.4%). The child of NRG Energy, this yieldco owns and operates such projects as a new district energy center in Pittsburgh that delivers steam, chilled water and backup power to UPMC Mercy hospital.

Pattern Energy Group (PEGI, $24, 7.0%, 30.1%, 9.1%). Its 18 wind-power facilities in the U.S., Canada and Chile benefit from Pacific Ocean breezes.

...and three new ideas Brookfield Renewable

Partners (BEP, $33, 5.4%, 14.3%, 6.5%) is a spin-off from the Kiplinger Income 25 stalwart with the symbol BIP. It has 250 renewable power facilities in North America, Latin America and Europe.

Hannon Armstrong Sustainable Infrastructure Capital (HASI, $23, 5.8%, 23.6%, 14.5%) finances solar- and clean-energy firms, making it an indirect way to get in on this growth burst.

NextEra Energy Partners (NEP, $38, 4.0%, 53.1%, 26.4%) owns fully contracted wind and solar projects throughout North America. It also owns some natural gas in Texas--but that's a small part of its holdings.

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Investing for Income: Strategies to Boost Your Cash Yield

August 2017

Standing Ovation for the Green Swans

Abunch of readers who caught our reference to the Green Swans in a recent letter are eager for an update. So for you, and for newer subscribers unfamiliar with the Swans, here's the scoop on our ultra-low-risk growth-and-income stock portfolio. Since our most recent review in January 2016's letter, the Swans have done splendidly. In the 20 months ending July 21, they averaged a total return of 24.1%--just about even with the Standard & Poor's 500-stock index, dividends included. Nine of the 10 delivered a profit, and eight gained in double figures. Our Swans also beat the Dow Jones industrial average and S&P 500 handily in 2015.

Who are these birds? They are born out of our thinking that when the stock market struggles, you shouldn't quit--but it's okay to trim risk. This portfolio is designed to protect capital in sell-offs but participate in rising markets. Each member of the flock must demonstrate a pattern of maximum share-price stability and secure and growing dividends. Just as important, each company must have moderate debt and command of an understandable and noncyclical business or businesses. The Swans passed a tough test the first six weeks of 2016, when the indexes plunged for no apparent reason. While the Dow and S&P 500 lost nearly 9% (counting dividends), the Swans lost just 1.9%, and five of the 10 stayed in the plus column during the swoon. The group has maintained that advantage all year; each member has raised dividends or will do so by year-end.

Swan is an acronym for "sleep well at night." It's also a backhanded reference to "black swan," an unpredictable catastrophe brought on by events such as an act of war, a series of bank failures, or default by a key country such as China or Russia. Here in the U.S., a failure to raise the Treasury's debt ceiling that ruined our nation's full faith and credit would be a black swan. We aren't in the business of predicting such shocks or recommending endof-the-world tactics. We prefer to seek out the green rather than obsess about the black. Here's the list. All figures below are as July 21, 2017.

Accenture (symbol ACN, $129, yield 2.0%, 20-month total return with dividends 26.1%). A 10% dividend boost this month is an extra reward.

Automatic Data Processing (ADP, $105, yield 2.2%, return 30.0%). Shares haven't had a losing year since 2008.

Coca-Cola (KO, $45, yield 3.5%, return 11.9%). Not a great growth stock now, but a safe dividend ace.

Genuine Parts (GPC, $83, yield 2.9%, return 1.1%). Recovered from a poor showing in 2015.

Illinois Tool Works (ITW, $147, yield 2.0%, return 67.1%). An 18.2% dividend increase started in October adds to a great record.

Lancaster Colony (LANC, $126, yield 1.7%, return 18.1%). It hasn't lost money for shareholders since 2008.

3M (MMM, $211, yield 2.5%, return 41.8%). One of the best

and steadiest members of the Dow, with the broadest range of products and services.

Sysco (SYY, $51, yield 2.5%, return 30.7%). This Swan flew somewhat out of formation when it took on $5 billion in debt to acquire a big British and Swedish food supplier. But Sysco stays because the debt is low cost and food distribution is steady and nonseasonal.

Walgreens Boots Alliance (WBA, $79, yield 1.8%, return -0.8%). The largest retail pharmacy in the U.S. and Europe hopes to conclude acquisition of Rite Aid Corp. early this year.

WD-40 (WDFC, $108, yield 1.8%, return 14.5%). Angling for faster growth, it might borrow to expand on its one-product fame. We'll keep an eye on it.

Timely Tactic of the Month

The yields of one-, two- and three-year Treasuries and investment-grade corporate bonds have edged closer to the rates of 10-year and longer T-bonds than you might imagine. That argues for the shorties--and not just from Uncle Sam. Browsing the corporate-note racks at Schwab's, we see the likes of Ford Motor Credit 2.5% notes due April 2019, rated BBB and selling at just about par (CUSIP 34540TLJ9), as well as Senior Housing Property Trust 3.25% notes due May 2019, rated BBB? and trading at a little over par (81721MAJ8). Both yield about 2.5% to maturity, depending on the daily trading, and that's almost as much as a 30-year Treasury. This is one credit risk you are definitely paid to take.

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August 2017

Investing for Income: Strategies to Boost Your Cash Yield

5

25

for Income

A calm month, and a bunch of our favorites rallied strongly. Our utilities extended their sizzling streak as American Electric Power tacked on 6.4% and CenterPoint added 5.8%. In real estate, Annaly Capital Management jumped 9.4%, to $12.36--its highest price since 2013, and high enough to knock the current yield below 10%. Welltower added 5.2%, and Realty Income gained 3.5%. Realty Income's price is holding above $55, even as other retail-property REITs keep sliding on general mistrust of the sector. Pimco Corporate Income & Strategy rose 4.0% as its premium to net asset value surpassed 10%. That is normally a sell signal for any closed-end fund, and PCN's year-to-date return on its share price is over 20%. But this is among Pimco's brightest stars and has an amazing 15year record; PCN has at times traded for even bigger premiums. Our only notable loser was Magellan Midstream Partners. The gasoline pipeline MLP dropped 5.4% despite another quarterly distribution boost. This midstream partnership is safe but could use a jolt of enthusiasm.

Utility stocks

Price

American Electric Power (AEP) AT&T (T) CenterPoint Energy (CNP) National Grid (NGG)

Traditional electric company serving 11 eastern and southern states

$72.42

Wireless-service giant that grew out of the former SBC 38.96

A major U.S. gas utility and owner of Houston Electric 28.88

British national gas and electric utility that also operates in New York and New England 65.97

High-yielding open-end bond funds

Aberdeen Global High Income (BJBHX) Buffalo High-Yield (BUFHX) DoubleLine Total Return (DLTNX) Fidelity Capital & Income (FAGIX) Fidelity New Markets Income (FNMIX) Loomis Sayles Bond (LSBRX)

Intermediate-term corporate bonds from all over the world $8.99 High-performance junk bond fund that also owns some convertibles for possible growth 11.28 Income fund that makes the most of mortgage securities 10.75 Creative and aggressive junk bond fund 10.03 Impressive emerging-markets bond fund 16.33 Go-anywhere investment-grade bond fund that is currently cautious 14.11

Closed-end mutual funds and ETFs

AllianceBernstein Global High Income (AWF)

High-yield corporate bonds and government bonds from emerging markets$12.84

Dreyfus Municipal Bond Infrastructure (DMB)

A fund that owns many road and transportation bonds 13.18

iShares Standard & Poor's U.S. Preferred Stock (PFF) ETF with hundreds of preferred stocks 38.98

Nuveen Municipal Value (NUV)

No leverage here, so less yield than Dreyfus Infrastructure but more safety 10.09

Pimco Corporate & Income Strategy (PCN)

An unusual mixture of high-yield corporate, muni and foreign bonds 17.05

Templeton Global Income Fund (GIM)

A combination of emerging markets and rich countries' government bonds 6.68

Real estate investment trusts

Annaly Capital Management (NLY) Digital Realty Trust (DLR) Realty Income (O) Welltower (HCN)

Borrows cheaply to reinvest in government-guaranteed mortgage securities$12.36 Developer and operator of data centers in the U.S., Canada, Europe and Asia116.61 Landlord to chain stores and restaurants, also known for 563 straight monthly dividends 56.67 Develops and owns assisted-living facilities, hospitals and medical labs 75.60

Energy investments and partnerships

Brookfield Infrastructure Partners (BIP)* Cedar Fair (FUN)* Magellan Midstream Partners (MMP)* Occidental Petroleum (OXY) Suburban Propane Partners (SPH)*

Owns toll highways, ports and transmission lines$40.24 Partnership that owns theme parks coast to coast 70.68 One of the largest pipeline carriers of gasoline, diesel and chemicals 69.83 A mostly domestic oil and gas producer 61.83 Nationwide supplier and distributor of LP gas and similar fuels 25.10

Funds in italics pay tax-exempt income. Investments with an asterisk (*) are partnerships. Prices and yields as of June 16, 2017. SOURCES: Fund companies, Morningstar Inc., Yahoo.

Yield 3.3% 5.0 3.7 4.5

5.4% 4.4 3.5 4.0 5.3 2.3

6.5% 4.8 5.8 3.9 7.9 4.1

9.7% 3.2 4.5 4.6

4.3% 4.8 5.0 4.9 14.1

Frequency quarterly quarterly quarterly semiannually

monthly monthly monthly monthly monthly monthly

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