High Yields In A Zero Rate Environment

Now more than ever, it’s a seller’s market for bonds of regulated electric, gas and water utilities.

Last week, CMS Energy (CMS) was able to upsize an offering of 30-year bonds from $300 to $400 million, even while cutting the coupon interest rate by 37.5 basis points. AES Corp (AES) sold $1.8 billion of senior notes in private offering, including 2026 notes priced to yield just 1.375 percent and 2031 notes at 2.45 percent.

Proceeds will retire notes due between 2023 and 2027 with coupon yields ranging from 4.5 to 6 percent. And the savings will flow right to the bottom line for this renewable energy-focused global power generation and distribution company, which for the first time in its history has achieved investment grade status at the parent level from two major credit raters.

AES’ rising fortunes have made winners of the pair of bonds I’ve recommended to readers. And I’m more convinced than ever that the company’s best days are ahead, as management slashes debt and fires up earnings growth with growing investment in steady cash flow-generating solar, wind and energy storage assets.

In addition to the bond offering, AES also announced it will absorb its Power affiliate, boosting ownership to 75 percent of a 12-gigawatt capacity renewable energy development pipeline. The remaining 25 percent is a passive stake held by deep-pocketed financial partner Alberta Investment Management Corp.

That’s all great news for owners of AES Corp stock, which now trades at roughly 2.5 times its mid-March lows and still sells for just 13.7 times expected next 12 months earnings. But despite getting bought out for a premium, it’s less positive for owners of the now called AES Corp 4.875 Percent notes of May 15, 2023.

Mainly, they now have to find a place to reinvest funds at a time when even longer-maturity high quality bond funds are yielding well south of 3 percent—and anything paying out significantly more than that is likely to be at considerable risk.

The iShares iBoxx High Yield Corporate Bond ETF (HYG), for example, still has an indicated yield of around 5 percent. But that comes with the risk of a portfolio weighted nearly half in BB junk bonds, with the rest rated even lower. And there’s exposure to an increase in benchmark interest rates as well, with roughly 60 percent of holdings maturing in five years or more.

Investors are far better off looking for income with a stock like Duke Energy (DUK), which yields almost as much and has proven its mettle as a business during this pandemic year. And unlike a bond or bond fund, the company will actually grow its dividend going forward as it invests $58 billion over the next five years, in large part by expanding rate-based renewable energy generation.

One of the biggest mistakes many income investors make, is assuming the bonds and preferred securities of a company are safer than its common stock. True, you will be first in line to get paid when there’s a cash shortage, or at least right behind lenders’ whose interests are secured by assets. But all things considered, investors don’t want to be in that sort of line.

There are times when a common stock dividend cut can be just the action needed to turn a company around, providing the critically needed cash to buy some breathing room for future recovery.

But unless there’s a compelling reason otherwise, investors should always assume that a problem hitting the value of the common has the potential to also take down the value of a company’s bonds and preferred shares. If you want to avoid the common stock, chances are you also want to steer clear of the fixed income securities.

That said, here are some ideas for you to consider.

Centerpoint Energy’s 7 Percent Mandatory Convertible Preferred of September 1, 2021 (CNP B, Cusip 15189T503). The security’s unique feature is that in a little more than nine months it will convert into between 1.5291 and 1.8349 shares of Centerpoint Energy (CNP) common stock.

The number of shares will be determined by a formula designed to produce an exchange value of $50 per preferred share. If Centerpoint trades at $27.25 or less at conversion, investors get the maximum number. If the common stock trades at $32.70 or higher, the preferred is swapped for the minimum. And in between the number will vary between those levels.

The preferred does pay a generous dividend of 87.5 cents per quarter, which equates to a current yield north of 8 percent. But the principal appeal is potential capital gains, as Centerpoint exits the 50 percent general partner and 53.7 percent interest in Enable Midstream Partners (ENBL). Unloading this riskier asset should help shares close their currently wide valuation gap with other utilities. And shed of Enable, there’s the possibility of a high premium takeover offer for the rest of the company as well. I’m expecting a final value at conversion of at least $50 and continue to like Centerpoint preferreds when they dip to a price of 42 or less.

As with individual companies, future returns on the iShares Global Green Bond ETF (BGRN) aren’t set in stone either. But in this case, there’s still a lot for conservative income seekers to like.

The ETF is highly liquid and pays dividends monthly at an attractive indicated annualized yield of 3.43 percent. But its best feature is the type of bonds it holds: Investment grade “green” bonds that are used to finance projects deemed beneficial for the environment.

Up until recently, I’ve been highly skeptical of green bonds’ worthiness as an investment vehicle. The companies able to issue them have received very low-cost financing, which is always a plus for shareholders. But the most attractive issues have been almost exclusively reserved for large institutions.

That’s left only questionable crumbs for individuals, like the SolarCity bonds that securitize cash flows from that company’s shaky rooftop solar contracts. Most of those now trade at sharp discounts to par value, a clear sign they were overpriced to begin with to take advantage of investors’ craving to go green, in an environment where supplies were limited.

What’s changed now is green bonds are starting to come of age as an asset class. And this iShares ETF is solid proof of that, with 484 high quality holdings from a wide range of countries and industries. Currency exposure is mitigated by the fund’s adhering to the Bloomberg Barclays MSCI Global Green Bond Select (USD Hedged) Index.

The fund’s proof of concept since its November 2018 inception is its 6.3 percent year-to-date total return. That includes a top-to-bottom decline of just -7.5 percent in March, a time of extreme stress in global financial markets including currencies.

With the US set to rejoin the Paris Accords next year, ESG investing based on environmental, social and governance principles is enjoying an unprecedented boom. That makes it certain green bond issues will continue to mushroom, which means more supply for ETFs like this one to fuel growth, even as growing investor interest continues to drive up prices. Consider buying the iShares Global Green Bond at current prices.

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