Energy ETFs, Stocks With High Yields

NEW YORK (TheStreet) -- Exchange traded funds enable investors to build portfolios, though dividends can be lacking.

All investment products have drawbacks, and a big one for ETFs is that many sector funds don't pay large dividends. I wrote a similar post on my blog about building financial holdings for a portfolio with an eye toward dividends using a combination of stocks and ETFs. Here I'll do the same with energy.

A couple of weeks ago, I wrote an article for TheStreet.com about the new suite of U.S. small-cap sector funds from PowerShares. A reader, a retiree, noted that their dividends are skimpy, rendering them unattractive.

Building portfolios at the sector level was important in the past decade, when the tech and financial industries blew past the S&P 500 Index at various points. Historically, when a sector grows past 20% of the S&P 500, it has led to big problems.

The most popular energy proxy is the Energy Select Sector SPDR(XLE), which has a trailing dividend yield of 1.66%, a little less than the SPDR S&P 500 ETF(SPY). The WisdomTree International Energy Sector Fund(DKA) can be part of the solution. Its dividend yield is 3.3%, but still not enough for an income-oriented investor.

Experienced investors may be inclined to look at the Claymore/SWM Canadian Energy Income Index ETF(ENY), which is heavily weighted in Canadian income trusts. But even that fund yields only 3.36%. Many do-it-yourself investors may not be comfortable with stocks because of the risk/volatility potential, but a combination of ETFs and well-researched stocks can make for a reasonable solution.

The energy industry currently comprises 11% of the S&P 500. One way to build a high-yielding sector position would be to put 5% of the portfolio into the WisdomTree International Energy Sector Fund, which is heavy in foreign mega-cap energy companies like BP(BP) and Total(TOT), and the other 6% in a couple of high-yielding stocks from different parts of the industry.

As an example, adding 3% weights in stocks like Ecopetrol(EC) and Kinder Morgan Energy Partners(KMP), in combination with the WisdomTree ETF, would meaningfully increase the dividend over the Energy Sector SPDR. Ecopetrol is an integrated oil company from Colombia that has a trailing yield of 5.8%. It has a $57 billion market value, carries little debt and has been a good proxy for emerging markets, albeit more volatile than the iShares MSCI Emerging Market Index Fund(EEM). Kinder Morgan Energy Partners is a pipeline company that currently yields 6.3%. The stock occasionally does nothing for months at a time and then moves much higher. The shares have surged 61% since the market low in March 2009, though the beta -- a measure of volatility compared with the broader stock market -- is only 0.30. One is a perfect correlation.

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