Barron’s Best Income Investments for 2021

Illustration by C.J. Burton

The bond market has been a barren field for income, as fixed-income yields remain stuck at historic lows. Yet there are rich pickings elsewhere—if you know where to look.

“With rates just barely above all-time lows, yield opportunities are clustered in the equity markets,” says David King, co-manager of the Columbia Flexible Capital Income fund.

That includes energy pipeline operators, telecommunications companies, real estate investment trusts, and electric utilities. Pipelines yield 8% or more; telecoms can get you 4% to 7%; REITs, 3% to 6%; and utilities, 3% to 4%. Many drug and consumer stocks also yield 3% to 4%.

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King says that income-hungry investors need look no further than the so-called Dogs of the Dow, the 10 highest-yielding stocks in the 30-stock Dow Jones Industrial Average. The Dogs now include Chevron (ticker: CVX), Verizon Communications (VZ), and Merck (MRK).

Outside the U.S., there are a number of yield plays in markets that have markedly lagged behind the S&P 500 index in the past decade.

Opportunities are more limited in bonds. U.S. Treasuries yield under 2%, and high-grade municipal bonds, 2% or less. Most preferred stock is in the range of 3% to 4%, and top-grade corporate bonds yield 4% or less.

The average yield on junk bonds is under 5%, and investors need to go to the riskiest corner of the market to get 8% yields.

This is Barron’s ninth annual assessment of income-producing areas of the stock and bond markets, in which we examine 12 sectors and rank them in order of preference. Our record last year was mixed. We were too bullish on energy pipelines and too cautious on Treasuries.

Here is how we rate the 12 sectors for 2021.

1. Energy Pipelines

The drop in oil prices and a growing investor aversion to the energy sector hammered pipeline operators in 2020. The Alerian MLP exchange-traded fund (AMLP) returned negative 32% for the year.

Yet the industry is doing better than its stocks suggest and could revive this year, particularly if oil-price bulls like commodity analysts at Goldman Sachs are right and West Texas Intermediate crude rises to about $60 a barrel from a recent $48.

“There is strong free cash flow, low valuation, 8% to 10% yields, and the potential for higher commodity prices and volumes,” says Greg Reid, president of Salient Partners, which runs the Salient Midstream & MLP closed-end fund (SMM). “There could be significant upside.”

Many pipeline companies began stock buyback programs in the fall, after some halted them in the spring in the wake of the pandemic.

Closed-end funds focused on pipeline operators—both master limited partnership and corporations—trade at wide discounts averaging about 20% to net asset value, and most yield in the range of 5% to 10%. The Alerian MLP ETF yields 11%.

Among industry leaders, Magellan Midstream Partners (MMP), at $42, yields 9.7%; Enterprise Products Partners (EPD), at $20, yields 9.1%; and Williams Cos. (WMB), at $20, yields 8%.

2. U.S. Dividend Stocks

As investors favored growth stocks in 2020, high-dividend payers languished.

The Vanguard High Dividend Yield (VYM) ETF, which is dominated by the largest high-dividend stocks, such as Johnson & Johnson (JNJ) and JPMorgan Chase (JPM), was flat in 2020, against a 17% return for the S&P 500. The ETF yields about 3.2%.

“One of the least popular parts of the stock market are established companies with good dividends,” King says. That could change in 2021 if the recent strength in value-oriented stocks continues.

One way to play it is through the 10 Dogs of the Dow, which had a poor year in 2020, returning negative 7%, against a 9% return on the overall index. Historically, the 10 Dogs have stacked up well against the overall Dow when investors rebalance their portfolio of Dogs at the end of each year. Besides Chevron, Verizon, and Merck, current Doghouse stocks include Cisco Systems (CSCO), Coca-Cola (KO), and Walgreens Boots Alliance (WBA).

The Columbia Dividend Opportunity fund (INUTX), which King co-manages, owns nine of the 10 current Dow Dogs. For investors who are willing to trade off a lower dividend yield for better growth potential, there is the ProShares S&P 500 Dividend Aristocrats ETF (NOBL), which yields about 2%.

3. Overseas Dividend Stocks

International markets are a great place to find yield because they have trailed U.S. indexes for 10 years. In addition, foreign companies tend to have higher dividend payout ratios than their American peers.

“We see much better opportunities outside the U.S. than inside the U.S.,” says David Iben, manager of the Kopernik Global All-Cap fund. He points to telecommunications, utilities, and energy.

Iben likes Eletrobras (EBR) of Brazil, a huge hydropower generator that trades at $7, or seven times 2021 earnings, and yields 4.7%. He is also partial to the Russian natural-gas behemoth Gazprom (OGZPY), which trades around $5.50, yields 7%, and is far cheaper based on reserves than its Western peers, reflecting Russian risk.

He also owns Mitsubishi (MSBHF) and Mitsui (MITSY), two of the Japanese trading companies whose shares were purchased by Berkshire Hathaway (BRK.B) last summer. The two companies have thinly traded U.S.-listed shares, trade below book value, and yield about 4%.

Drug shares lagged behind the market in 2020. European drug giant Novartis (NVS), at $93, trades for 14.5 times projected 2021 earnings and yields 2.1%, while rival GlaxoSmithKline (GSK), at $37, trades for 11.5 times estimated 2021 earning and yields 5.4%.

Broad overseas ETFs yield around 2%, including iShares Core MSCI EAFE (IEFA), Vanguard FTSE Europe (VGK), and iShares Core MSCI Emerging Markets (IEMG).

4. Electric Utilities

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The sector had a disappointing year, considering the drop in interest rates, but 2021 could be better as investors gravitate toward an industry that will spend heavily in the next decade to develop renewable power.

The Utilities Select Sector SPDR ETF (XLU) has generated a negative 1% return in 2020. Utilities could generate a 10%-plus return in 2021, reflecting dividend yields averaging close to 4% and price appreciation in line with earnings growth.

“We see structural decarbonization, robust growth opportunities, a defensive business model, and solid yield underpinning an attractive outlook for the group,” J.P. Morgan Securities analyst Jeremy Tonet wrote in a recent note. He views the group as appealing; it is valued at an average of about 18 times 2021 earnings, a discount to the S&P 500 multiple of 22 times.

Tonet is partial to Dominion Energy (D), now a nearly pure-play regulated utility in Virginia with an ambitious renewable-energy plan. The stock, at about $74, trades for less than 20 times projected 2021 earnings. It yields 3.4% after a dividend reduction in 2020 that resulted from the sale of a gas-pipeline business to Berkshire Hathaway.

Some utility stocks were battered in 2020, including Consolidated Edison (ED) and PPL (PPL). Each fell about 20%, while industry leader NextEra Energy (NEE), a leader in renewable power, gained 20%. Con Ed, at about $71, yields 4.3% and trades for about 16 times 2021 earnings. Duke Energy (DUK) and American Electric Power (AEP) fetch about 17 times projected 2021 profits, and NextEra, 30 times.

5. Real Estate Investment Trusts

Hurt by weakness in malls, apartments, and office buildings, the REIT market, as measured by the Vanguard Real Estate fund (VNQ), returned negative 6% in 2020. Industrial REITs like Prologis (PLD) that own warehouses were a bright spot, benefiting from the e-commerce boom. The Vanguard ETF now yields 4%.

“Interest rates are very low, and that bodes well for REITs,” says Alexander Goldfarb, a REIT analyst at Piper Sandler. Real estate companies should get a lift from a stronger economy in 2021.

Goldfarb is partial to mall industry leader Simon Property Group (SPG), whose shares, at about $83, yield 6.2%, and shopping center owners Kimco Realty (KIM), at $14, yielding 4.5%, and Brixmor Property Group (BRX), at $16, yielding 5.3%.

“Bricks-and-mortar retailers remain essential,” Goldfarb says. “People can’t get everything they need on Amazon.”

He sees Simon as a deep-pocketed mall survivor with a desirable portfolio and strong balance sheet. Owners of strip malls like Kimco and Brixmor are getting a lift as more Americans prefer the convenience of buying online and then picking up products at local stores.

The New York City office sector was hit hard in 2020. One way to play a rebound is through Vornado Realty Trust (VNO), which has a depressed price of $36 (down 45% in 2020), a good balance sheet, and an attractive portfolio of Manhattan office towers. It yields 6%.

Goldfarb likes Douglas Emmett (DEI), which has what the company calls an “irreplaceable” office portfolio concentrated in the affluent western part of Los Angeles. The shares, at about $29, yield 3.9%. “The people who live and work on the west side of L.A. aren’t going to Texas,” he says.

6. Telecommunications

The two major U.S. telecom companies, Verizon and AT&T (T), had a disappointing year. Verizon shares declined 4%, yielding 4.3%. AT&T fell 27%, yielding 7.3%—one of the highest dividends in the S&P 500.

Verizon looks to be the stronger of the two, with a better balance sheet and a competitive position in the U.S. wireless market. Craig Moffett, an analyst with MoffettNathanson, upgraded Verizon to Buy from Neutral in early December and set a $66 price target. His view is that Verizon, which fetched a recent $58.81, is simply “too cheap,” trading for about 12 times projected 2021 earnings of $5 a share, half the market multiple. He sees high revenue per customer in 2021 and better roaming revenues relative to a Covid-depressed 2020.

AT&T has expressed commitment to its dividend, but analysts like Moffett worry about an expensive iPhone 12 promotion and pressure on its large media business. At a recent $28.57, AT&T trades for only nine times estimated 2021 earnings.

Overseas telecommunication companies are even cheaper than their U.S. counterparts.

Kopernik’s Iben likes KT (KT), one of the largest South Korean telecom companies, and China Mobile (CHL), the largest cellphone company in China. Both stocks have badly lagged behind Verizon in the past decade.

Both KT and China Mobile trade at seven times 2021 earnings estimates. KT, at $11, yields 4%, while China Mobile, at $28, yields over 5% and has net cash equal to about half of its market value.

[On Friday, after publication of this story, the Wall Street Journal reported that the New York Stock Exchange will move to delist China Mobile and other Chinese telecom firms to comply with a U.S. government order barring Americans from investing in companies that it says help the Chinese military. The delisting is due to occur by Jan. 11.]

In Europe, Deutsche Telekom (DTEGY), at about $18, yields 3.7% and owns a large stake in T-Mobile US (TMUS) that is worth nearly as much as its market value. The German telecom has considerable debt.

7. Convertibles

The bond/stock hybrid securities befuddle many, but after their blockbuster performance in 2020, convertibles ought to attract greater investor attention.

Convertibles returned about 45% in 2020, based on the ICE BofA U.S. Convertible index, making them one of the best U.S. asset classes. The gain was powered by a huge gain in the share price of Tesla (TSLA), which makes up about 10% of the $325 billion “convert” market. Tesla accounted for about 40% of the index’s advance.

Growth-oriented technology companies are well represented in the convert market, helping performance. Another boost came from “rescue” converts sold early last year by companies pressured by the pandemic, including Carnival (CCL), Southwest Airlines (LUV), and Booking Holdings (BKNG).

“We’re calling for 8% to 11% performance in 2021,” says Michael Youngworth, head of global convertibles strategy at Bank of America. The market’s heavy weighting in growth stocks makes it vulnerable to a pullback in the tech sector.

Youngworth says that converts continue to offer a favorable risk/reward equation: “You get more appreciation on the upside when stocks rise than you lose on the downside.”

The largest convertible ETF, the SPDR Bloomberg Barclays Convertible Securities (CWB), gained 51% in 2020. It now yields 2.4%.

8. Junk Bonds

Investors have piled into the junk market in recent months, buoyed by optimism about the economy in 2021.

The result is that the ICE BofA High Yield index yields under 5% and investors need to take considerable risk—in bonds with low-grade triple-C ratings—to get an average yield of 8%.

Junk returns in 2021 could top the 5% level of 2020 if the economy recovers and investor demand stays strong.

Yet Martin Fridson, chief investment officer of Lehmann Livian Fridson Advisors, is cautious.

“High-yield prices convey a level of optimism that is very difficult to reconcile with the credit outlook unless you count on continued Fed support on a level never witnessed prior to 2020,” Fridson says. “Investors are pricing high-yield bonds such that the market is effectively predicting a 2% default rate over the next 12 months. This compares with 8% over the past 12 months, as reported by Moody’s.”

The largest junk ETF is the iShares iBoxx High Yield Corporate (HYG) at $26 billion, yielding about 5%. The smaller VanEck Vectors Fallen Angel High Yield Bond (ANGL) ETF, yielding 4%, generated some of the best performances in the sector last year and over the past five years. It returned 13% in 2020; large holdings include Carnival and Kraft Heinz (KHC).

9. Tax-Exempt Municipals

The market went from feast to famine back to feast in 2020. After a strong start, munis were buffeted in the immediate aftermath of the pandemic and then mounted a strong rally into year end, finishing with a return of about 5%.

With yields near historic lows, though, it’s tough to make a strong case for munis. An index of triple-A-rated 10-year munis yields just 0.7%, not far from the record low of 0.55% in August. And that index yields just 75% of the 10-year Treasury note, near the lowest point in 20 years and below the average of close to 100%. The yield is less than half of the U.S. inflation rate.

Lower-grade munis trailed their top-grade brethren in 2020, but have rallied in recent months. One winner lately has been the financially troubled Metropolitan Transportation Authority, which operates New York City’s subways. Its 35-year debt now yields about 2.75%, down from 5% in May. Top-grade long-term munis yield 1.5%.

Peter Hayes, the head of the municipal group at BlackRock, says a shift in issuance to taxable muni bonds, which now account for about 30% of the new-issue municipal market of about $450 billion annually, should “provide a tailwind” to the tax-exempt market in 2021.

The largest muni fund is the $80 billion Vanguard Intermediate-Term Tax-Exempt (VWITX), which yields 2.3%. One alternative to the Vanguard fund is the Parametric TABS 5-to-15-Year Laddered Municipal Bond fund (EALTX), which follows a similar strategy to Parametric’s popular separately managed accounts. (Laddering refers to buying munis of different maturities in the same portfolio as a way of diversifying.) The Parametric fund, which is owned by Eaton Vance, has topped the Vanguard intermediate fund over the past five years. It yields 1.6%.

Closed-end muni funds yield more—reflecting leverage—and generally trade at discounts to their net asset value, or NAV. Current discounts in the mid-single digits are less attractive than the regular double-digit discounts that were prevailing before 2020.

The BlackRock Municipal 2030 Target Term Trust (BTT), at around $25, yields 3% and trades at a 6% discount to NAV. It is set to mature in 2030. The lower-grade Nuveen Municipal Credit Opportunities fund (NMCO) trades around $12.75, yields 5.8%, and trades at an 8% discount to NAV.

10. Taxable Municipals

The formerly obscure market has exploded in size, with issuance totaling about $170 billion in 2020, double the amount in 2019.

State and local governments that want to refinance older high-rate tax-exempt debt before maturity must do so in the taxable muni market because of federal tax law changes in 2017. That has been the main driver of the taxable issuance boom, and it is likely to persist in 2021.

For investors, the appeal is that yields generally exceed those on like-rated corporate debt. Yields are in the range of 1.5% to 5%, depending on maturity and credit quality.

“There is a lot of demand, and we expect that to continue into 2021,” says BlackRock’s Hayes. He notes that the overwhelming percentage of demand comes from institutional investors, unlike the tax-exempt market.

There are three closed-end funds specializing in taxable munis that yield 4% to 5%, reflecting leverage and longer maturities. They are BlackRock Taxable Municipal Bond Trust (BBN), Guggenheim Taxable Municipal Bond & Investment Grade Debt Trust (GBAB), and Nuveen Taxable Municipal Income (NBB). All three trade at premiums to their net asset value.

The one large open-end fund is MainStay Mackay U.S. Infrastructure Bond (MGVAX). It yields 1.5%, reflecting shorter maturities and no leverage. The largest ETF is the $2.2 billion Invesco Taxable Municipal Bond (BAB), which yields about 2.5%.

11. Preferred Stock

The preferred market, which has been booming, presents difficult decisions for investors weighing risk and return.

Nearly all of the $350 billion sector, which is dominated by bank issuers, trades at a premium to face value.

Currently, preferred securities have little upside and considerable downside if rates rise. Most are perpetual securities, meaning that they have no maturity dates.

Preferred securities issued at $25 a share now often trade in a range of $26 to $28. Yields are generally 3%, calculated more or less to the early redemption, or call, price of $25 occurring in the next few years. Some even have negative yields. Preferred securities can normally be redeemed by the issuer at face value five years after the offering date.

New issues are coming to market with yields of about 4%, down from 5% in the spring. Bank of America sold $1.1 billion of 4.375% preferred in October (BAC Pr O), and it now trades at $26 for a yield to call of 3.2%.

Public Storage, a self-storage REIT and sizable preferred issuer, sold $175 million of 3.90% preferred (PSA Pr O) in November. It trades around $25.50.

One high-yielding preferred that still looks appealing is Qurate Retail’s (QRTEP) 8% issue due in 2031 that trades around 98, just below its face value of 100.

Qurate owns the QVC home-shopping channel and is controlled by media magnate John Malone, who holds about $85 million worth of the Qurate preferred.

The largest ETF, the iShares Preferred & Income Securities (PFF), trades around $38 after a 7% total return in 2020, and yields 4.8%. Closed-end funds focused on preferred yield more, reflecting leverage. The Nuveen Preferred & Income Opportunities fund (JPC) trades about $9, yields 6.8%, and trades at a 3% discount to its NAV.

12. Treasuries

*Since issuance in 2020

Source: Bloomberg

Government bonds lived up to their billing as a stock market hedge in 2020. Rates plunged as stocks collapsed in March, and the Treasury market finished 2020 with yields not much above the pandemic panic lows and down half a percentage point or more for the year.

The 10-year Treasury note yields 0.95%; the 30-year Treasury bond, 1.7%; and short-term Treasury bills yield near zero, reflecting the desire of the Federal Reserve to hold short rates around zero for the next few years.