Since the depths of the financial crisis, it hasn't been easy going for income seekers. Sure, bond prices have surged as investors have continued to flock to safety, and that certainly results in some nice capital appreciation, but no good deed goes unpunished. Those rising bond prices have pushed dividend yields on products like the Vanguard Short-Term Bond ETF down lower and lower. At the same time, the Federal Reserve, in order to stimulate growth, has kept interest rates at historically low levels. That's caused other traditional income products, like CDs and money market accounts, to pay roughly zero.

Add these low yields to rising inflation expectations and the current investing environment isn't so friendly for bonds. With millions of Baby Boomers about to enter their golden years, finding good sources of high income has become a paramount issue. Luckily, the exchange traded fund boom has given investors access to a variety of bond types that should do well in the current unfriendly bond environment.

SEE: Bond ETFs

Low Yields, High Inflation
According to J.P. Morgan's CIO Gary Madich, the current rate environment is "beyond challenging" for bond investors. First, with interest rates at historically low levels, most traditional sources of income such as cash, CDs and short-term bond funds are paying next to nothing. When adding in current and future inflation expectations, many of these asset classes are actually losing purchasing power. That has caused many investors to expand outwards to bonds with longer maturities; however, that's no bargain either.

With long-term inflation expectations high, eventually the Fed will have to raise rates. Ultimately, that will cause a portfolio of fixed-income securities to lose value. Bonds with longer maturities suffer more than those that are shorter. The longer the maturity of the bond, the bigger the swing in prices. Again, with short-term bonds paying next to nothing, investors looking to fund their liabilities today are facing a quandary.

Luckily, the proliferation of ETFs has created some ways to help navigate the current bond environment. Here are some ideas for a few strong portfolio contenders.

SEE: Active Vs. Passive ETF Investing

Betting on Bank Loans
With rates that adjust every 30 to 90 days, senior-rate bank loans make an attractive portfolio option in the current environment. Senior loans are generally issued to companies with less than stellar credit ratings and are often secured by a company's physical assets, such as a pipeline, warehouses or equipment. That fact allows them to offer higher starting yields than treasuries, but the adjusted rate feature allows them to perform well in rising rate environments.

The PowerShares Senior Loan Portfolio is the largest ETF in the sector. The fund tracks 117 different floating rate loans from a variety of issuers and the average coupon duration/reset is just 32 days. That means the ETF's impressive 5.1% distribution yield will only grow when the Fed raises rates. Expenses run a relatively cheap 0.76%. Likewise, the new iShares Floating Rate Note makes an ideal portfolio candidate as well.

Big Yields in Hybrid Bonds
While preferred stock has been widely adopted by the general investing public, their bond/equity twins, convertible bonds, have been largely ignored by retail portfolios. At their core, convertibles are basically a bond with a stock option hidden inside. Much like traditional bread-and-butter bonds, converts have face values, coupon payments and maturity dates, but can be exchanged for a specific number of shares of the issuer's common stock at a later date.

That allows investors to collect a treasury beating yield today, while participating in any upside in the stock market. Typically in high inflation environments, investors will seek higher returns and rush into equities to get ahead. With nearly $779 million in assets, the SPDR Barclays Capital Convertible Securities is the largest ETF in the sector. The fund tracks 101 different converts from issuers such as Intel and Chesapeake Energy and yields a healthy 3.29%. The ETF has performed well, producing an annualized 12.47% return since its inception in 2009.

SEE: Convertible Bonds: Pros And Cons For Companies And Investors

Look Across the Pond
Finally, one of the better solutions to realizing current high yields, as well as protecting for tomorrow, can be found by looking across the sea to other nations. As the dollar is expected to resume its multi-year decline, getting paid in a variety of other stronger currencies will help lessen interest rate risk. Likewise, many foreign issued bonds offer higher current yields than similar U.S. sponsored debt. Both the Market Vectors Emerging Markets Local Currency Bond and the actively managed WisdomTree Emerging Markets Local Debt provide investors with generous 4 to 6% dividend yields and make a good choice in the international bond space.

The Bottom Line
With interest rates low and inflation expectations high, investors seeking income are faced with a huge problem. Traditional income sources just aren't cutting the mustard for portfolios. Luckily, the exchange traded fund boom has given the average retail investor the ability to add some "alternative" bond types to a portfolio. The previous ideas are great ways to play the current difficult environment for bonds.

Related Articles
  1. Mutual Funds & ETFs

    ETF Analysis: Vanguard Total World Stock

    Learn about the Vanguard Total World Stock exchange-traded fund, which invests in stocks located in numerous countries with a high level of diversification.
  2. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  3. Mutual Funds & ETFs

    ETF Analysis: BioShares Biotechnology Products

    Learn more about the BioShares Biotechnology Products fund, an exchange-traded fund that is focused on producers of FDA-approved drugs.
  4. Mutual Funds & ETFs

    ETF Analysis: SPDR EURO STOXX 50

    Learn about FEZ, the Euro Stoxx 50 ETF. FEZ tracks the 50 largest companies in Europe, making it the Dow Jones Industrial Average of Europe.
  5. Mutual Funds & ETFs

    ETF Analysis: ProShares UltraShort Nasdaq Biotech

    Learn more about an innovative inverse-leveraged sector exchange-traded fund, or ETF, the ProShares UltraShort Nasdaq Biotechnology fund.
  6. Chart Advisor

    Value Stocks Offer Stability in a Volatile Market

    With volatility on the rise, investors are turning to segments of strength such as value stocks. We'll take a look at several ETFs that could be worth a closer look.
  7. Professionals

    Your 401(k): How to Handle Market Volatility

    An in-depth look at how manage to 401(k) assets during times of market volatility.
  8. Mutual Funds & ETFs

    ETF Analysis: Market Vectors EM High Yield Bd

    Learn more about the Market Vectors Emerging Markets High Yield Bond ETF, a fund dedicated to subinvestment grade foreign debt issues.
  9. Mutual Funds & ETFs

    ETF Analysis: First Trust Tactical High Yield

    Find out more about the First Trust Tactical High Yield fund, a debt security-focused ETF designed to produce high income.
  10. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI South Africa

    Learn more about the iShares MSCI South Africa fund, which is an NYSE-listed exchange-traded fund offered and managed by BlackRock.
  1. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets ...
  2. Brazil, Russia, India And China ...

    An acronym for the economies of Brazil, Russia, India and China ...
  3. Credit Rating

    An assessment of the credit worthiness of a borrower in general ...
  4. Optimal Currency Area

    The geographic area in which a single currency would create the ...
  5. European Sovereign Debt Crisis

    A period of time in which several European countries faced the ...
  6. Regional Asset Liquidation Agreement ...

    An agreement between an asset manager and the Federal Deposit ...
  1. What does a high turnover ratio signify for an investment fund?

    If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>
  2. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
  3. What is the difference between passive and active asset management?

    Asset management utilizes two main investment strategies that can be used to generate returns: active asset management and ... Read Full Answer >>
  4. Is there a situation in which wash trading is legal?

    Wash trading, the intentional practice of manipulating a stock's activity level to deceive other investors, is not a legal ... Read Full Answer >>
  5. How can I use the funds from operations to total debt ratio to assess risk?

    The funds from operations (FFO) to total debt ratio is used in fundamental analysis to determine a company's financial risk. ... Read Full Answer >>
  6. Are there leveraged ETFs that follow the retail sector?

    There are many exchange-traded funds (ETFs) that track the retail sector or elements of the retail sector, and some of those ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!