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As yields on Treasury bonds sink to record lows over renewed concerns in the eurozone, income investors are learning to live with frustration. It's getting harder and harder to squeeze a respectable yield out of any investment anymore, and desperate investors are on the hunt for better-looking opportunities. Unfortunately, yield alone is not a good indicator of an investment's relative suitability. In fact, here are three high-yield funds that contain more danger than opportunity:
The Spanish flu
Looking for a solid, low-risk fund that offers you an 11.3% trailing-12-month yield? Yeah, me too, but you won't find that in the iShares MSCI Spain Index ETF (NYSE: EWP ) . This fund is brimming with risk and potential land mines. In case you haven't been paying attention, Greece isn't the only European nation in danger of defaulting -- Spain isn't much farther behind Greece on the road to fiscal ruin.
In fact, just today, 10-year yields on Spanish bonds touched levels over 7.5%, a euro-era high for the nation. Stock market performance for the nation has been dismal as well; this fund has lost more than 40% in the last year alone. And that is what makes this fund a classic yield trap -- the only reason the yield is so high is because the price of the underlying index has fallen so drastically. That's not the sort of investment income investors need in their portfolio right now.
While some danger-seekers may find trolling for bargains in endangered sectors of the market appealing, the majority of investors should stick to better-diversified, and lower-risk, foreign investments in the current environment. For cheap, broad coverage of foreign developed markets, consider the Vanguard MSCI EAFE ETF (NYSE: VEA ) or the Vanguard MSCI Emerging Markets ETF (NYSE: VWO ) for exposure to developing nations. Just keep in mind that the turmoil overseas is far from over, so you need to be prepared for more big bumps in the road ahead.
Overly focused thinking
Sector-focused exchange-traded funds have always rubbed me the wrong way. While they can certainly be helpful for investors looking to home in on a very specific portion of the market, more often than not they end up in the hands of performance-chasers who are trying to make a quick buck from the latest hot performer. When you drill down into specific industry-level funds, you're really cranking up the risk. Such is the case with the Guggenheim Solar ETF (NYSE: TAN ) and its 11.5% 12-month trailing yield. This fund tracks the performance of the MAC Global Solar Energy Index, a very narrow subsector of the energy market. The smaller the market segment your fund focuses on, the greater the potential reward and risk.
Unfortunately for this fund, its risks have been on display lately, as it has lost nearly three-quarters of its value in the past year alone. And while the average energy equity mutual fund has lost more than 30% since this fund's inception in May 2008, the Guggenheim Solar ETF is down more than 90%. As with the Spain ETF, that incredible drop in price is what has driven the fund's yield up to double-digit levels. So don't count on a fund like this to provide consistent dividend yield payouts within a portfolio already struggling for income.
While strategies that focus on dividend-paying companies should prove fairly successful in the current market, not every dividend-focused fund is a clear winner. The First Trust STOXX European Select Dividend Index ETF (NYSE: FDD ) is one investment that may have a rough ride in store for it in the months ahead. While the fund holds many solid, financially stable blue chip names, it is rather concentrated -- just 30 companies make the cut into the portfolio.
That means risk is elevated here since individual stock movements have an outsized effect on the overall portfolio. For example, witness the fund's 60% loss back in 2008. And while the fund's 6.2% trailing yield may seem attractive, keep in mind that there's still a lot of risk in Europe where this fund shops, and further price drops are a distinct possibility. If you want a foreign dividend play, stick to more diversified funds that take a true global focus instead of a region-specific one.
In the end, the search for safe yield will continue as the usual sources of return dry up. While it's OK to look to alternate avenues for income, make sure you dig deeper than just looking at high yields. Yield is only a small part of the story, so don't be afraid to kick the tires of any investment before it finds its way into your portfolio.
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