With the economy sluggishly plodding along and the Federal Reserve hinting at another round of quantitative easing, low interest rates are surely here to stay for a long time. Investors looking for income from their portfolios are having a tough time. Investment vehicles such as the iShares Dow Jones Select Dividend Index (NYSE:DVY) or PowerShares Financial Preferred (NYSE:PGF) are gaining popularity as these investors look for alternatives beyond traditional CDs and money market funds. Another security type created during the first stimulus package might be a good choice for those seeking income.
Building America: One Bond at a Time
The state of America's infrastructure is quickly turning poor. Millions of dollars need to be spent on improving the nation's roadways, sewer systems and telecommunications infrastructure. However, the credit crisis affected states and municipalities just as much as it did individuals. Included in the American Recovery and Reinvestment Act, Build America Bonds were created as way for states and cities to help tap the constrained credit markets. Stevens Point, Wisconsin, was first to test the security, selling $3,650,000 worth of bonds. Since then, the program has become increasingly successful. More than $125 billion worth of bonds have been sold, accounting for more than 21% of all new issuances.
Build America Bonds work slightly different than traditional munis. When a government issues a Build America Bond, it receives a cash subsidy from the federal government equal to 35% of the coupon interest rate on the bond. This makes these bonds cheaper as a funding solution. In exchange for that interest subsidy, Build America Bonds are taxable.
With the program set expire at the end of 2010; many governments have been issuing long maturity bonds in order to take advantage of the interest break, essentially changing the municipal market into a two-tier caste, with new tax-free bonds carrying shorter maturities and taxable munis carrying longer ones. For example, a recent Pennsylvania bond offering included $600 million of Build America Bonds with rates of 4.65% for 16 years and 5.45% for 20 years. Pennsylvania then issued $300 million worth of tax-free munis, with maturities of one to nine years at yields from 2% to 4.3%.
Adding Some BABs
The Obama administration has proposed that the program be made permanent or extended, and the interest rate subsidy be reduced to 28%. Even if this event doesn't occur, the long timelines of these bonds assure a robust secondary market. Build America Bonds offer high yields and could be exactly what income seekers need to round out a portfolio. BABs carry ratings from triple A to junk. A broad based strategy works best.
The PowerShares Build America Bond (NYSE:BAB) was the first exchange-traded fund to exploit the new security type. The fund also has the lion's share of assets, with more than $560 million under management. The fund holds 300 different bonds, ranging from tax-revenue bonds to water and sewer issues. The fund charges a cheap 0.35% and yields a healthy 5.22% dividend. Similarly, the SPDR Nuveen Barclays Build America Bond (Nasdaq:BABS) offers exposure, but hasn't managed to catch on like the PowerShares fund. The BAB SPDR only has about $20 million in assets.
Bond house PIMCO has managed to carve a niche with its actively-managed ETF products, such as PIMCO Enhanced Short Maturity Strategy ETF (Nasdaq:MINT). Recently, the asset manager added the PIMCO Build America Bond Strategy (Nasdaq:BABZ) to its arsenal. The active management function allows its managers to allocate a percentage of assets to higher-yield junk bonds in order to boost yield and returns.
Finally, the closed-ended Nuveen Build America Bond Fund (NYSE:NBB) uses leverage to boost its distribution yield to nearly 7%. The fund trades at a slight premium to its NAV, and it might be worth it for the extra boost in yield.
The Bottom Line
As interest rates continue to stay low, income seekers have to look at more alternatives to achieve yield. Build America Bonds offer investors away to help fund the nation's much needed infrastructure build out, while getting great dividends. The previous ETFs offer an easy way to add these securities to a portfolio. (For related reading, take a look at Build America Bonds: Should You Buy?)
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