Seeking safe haven in economic storm

by Stephen Butler

Contemplating the market turmoil of 2008, I found myself thinking about Bob Dylan's song "Dirge," where he sings, "In an age of fiberglass, I'm looking for a gem."

I'm also reminded of former Gov. Jerry Brown, who said at the time, "we need to lower our expectations." That was when, as governor, he set a tone for asceticism by sleeping on a mattress on the floor of his Sacramento apartment. That was after a day of riding around like the Blues Brothers in a Dodge police car that had otherwise been put out to pasture.

Given the chance that we will be slipping into a recession, coupled with a stock market that will drive us nuts, it would be nice to find a gem in the way of some secure, income-generating investments. This is not to say that we should bail out of the market, but to the extent that we have at least some money in fixed income investments anyway (like bond funds or money market funds,) it would be wise to make that money as efficient as possible.

The starting point for generating higher income would be a GNMA investing in government guaranteed mortgages. Both Fidelity and Vanguard offer good candidates that are currently yielding about 5 percent.

For the more adventurous, there are some mortgage real estate investment trusts (REITs) that are paying between 7.6 percent and 9 percent with risk levels that most of us can live with. The MFS Government Markets Income (NYSE:MGF) is paying 7.6 percent.

For those who can live with more volatility but who care primarily about a consistent income stream, there is yet another mortgage REIT that has survived the deluge in the form of preferred shares. These are currently paying a yield of 8.2 percent.

Next up would be high yield corporate bond funds, which are replacing maturing older bonds with new ones that are suddenly paying as much as 10 to 11 percent. As late as last summer, the rate was typically 7.5 percent.

Over time, as the older bonds are replaced by newer ones reflecting higher interest and more risk, the rate of return for the fund overall will rise. This assumes that junk bonds won't default in a softening economy, but the high yield bond category offers varying levels of risk in this respect.

Vanguard's high yield corporate fund, for example, has been run for 30 years by Wellington Management and tends to buy bonds that are only slightly below investment grade. Its number of actual defaults has been negligible, and its yield, or annual payouts based on its current price, is 8.3 percent.

Foreign debt can be attractive as well. When U.S. investors flocked to our own Treasury bonds last year, they bid up the price of those securities, creating the effect of reducing the rate of return.

The interest rate on a bond is fixed, so your rate of return is determined by the amount you pay for the bond. Lower price means higher yield, etc. Meanwhile, in Australia, a 10-year treasury bond was paying 6 percent while ours was paying less than 4 percent.

Other governments, such as India and South Africa, offer bonds that qualify to be "investment grade" (meaning they are highly unlikely to default), and the yield on these bonds can be as much as 9 percent. It's impractical to actually invest in bonds in overseas markets, but mutual funds will do it for you.

Take a look at T. Rowe Price Emerging Markets bond fund. Its yield is currently 8.6 percent. The T. Rowe Price International bond fund investing in established countries is yielding 5.4 percent.

Meanwhile, we can't overlook dividends. Eaton Vance Dividend Builder invests in a variety of utility companies -- both power and communications. Its investments are divided equally between the U.S. and foreign countries. Its current yield is 10.6 percent, but it is a load fund, so it would require a long-term hold to be beneficial. A cheaper alternative would be Vanguard's Dividend Growth fund.

For a periodic update of income-generating ideas, consider subscribing to High Yield Investing at http://www.StreetAuthority.com. You ultimately have to do your own research, but this newsletter offers good food for thought. There's a pearl somewhere in one of those oysters.

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