When investors add a commodities component to a portfolio, they generally do so for capital gains exposure. Commodities are seen as the perfect way to add inflation protection. After all, inflation hits most of us in the food we eat and energy we consume.
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Exchange-traded funds such as the Energy Select Sector SPDR (NYSE:XLE) or PowerShares DB Commodity Index Tracking (NYSE:DBC) make perfect portfolio additions for that purpose. However, from an income perspective, both ETFs fall flat. The Energy SPDR actually yields less than the S&P 500 (NYSE:IVV). Those investors looking for income shouldn't fret; there are plenty of options for wages inside the commodities patch.
With the recent launch of the Alerian MLP ETF (Nasdaq:AMLP), portfolios now have six different ways to tap master limited partnerships. These pipelines, storage and terminal operators and their resulting "pass-through" tax structures have become big hits with investors seeking income. This structure allows for MLPs to pay distributions in the 5-7% range, while allowing for certain tax advantages for investors.
Although this sector should be a part of almost any income portfolio, with the recent frenzy, many analysts are calling a top in the sector. It may not be wise to go heavy into security type. The commodities segment offers other income choices beyond the world of MLPs. (For more on MLPs, see Discover Master Limited Partnerships.)
For investors wanting to stick to the familiarity and safety of diversified exchange-traded funds, some commodities ETFs yield better than others. Canada is known for its vast natural resources including the potential huge oil reserves locked in its oil sands. The Claymore/SWM Canadian Energy Income (NYSE:ENY) follows 26 different Canadian energy firms an yields 3.38%. The fund also functions as away to play the difference in oil and natural gas prices. Holdings within the ETF shift toward oil when oil prices are high and conversely with natural gas when natural gas futures increase.
Internationally, there seems to be more of a dividend culture and the yields of their equities reflect that. Energy companies such as Italy's Eni (NYSE:E) yield more than their domestic counterparts. The WisdomTree International Energy (NYSE:DKA) and its 4.89% distribution yield, follows a basket of 60 of the largest energy companies outside the United States.
Timber is emerging as an alternative asset class that can add portfolio diversification benefits and lower volatility. Albeit not a perfect correlation to timber prices, real estate investment trusts that focus their operations on lumber and land management can provide big dividends. Potlatch (NYSE:PCH) owns nearly 1.6 million acres worth of timberlands. Shares of the company currently yield 6.10%. Similarly, rivals Plum Creek Timber (NYSE:PCL) and Rayonier (NYSE:RYN) both yield over 4%.
United States Royalty Trusts, which differ from their Canadian cousins, generate dividend income from the development of natural resources such as coal, natural gas and crude oil. Like MLPs, they pass these dividends onto unit holders. When the price of the underlying commodity is high, so are the distributions. Investors wanting to play the growth in iron ore usage can bet on the Mesabi Trust (NYSE:MSB) and its 12% yield. Natural gas exposure can be had with the Permian Basin Royalty Trust (NYSE:PBT) and Cross Timbers Royalty Trust (NYSE:CRT). Both yield around 7.2%
The Bottom Line
Investors often look to commodities as inflation fighters and capital gain makers in a portfolio. However, income options exist as well. Investors looking to add yield to a portfolio can look past the heavily traded commodities ETFs such as the Market Vectors Steel ETF (NYSE:SLX) and look at some of the alternatives. The previously mentioned stocks and funds are a good place to start.
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