The definition of “alternative assets” is a bit hazy, but I interpret it as anything outside the usual stocks, bonds, or cash. We’re talking about assets on the fringes—those typically used by institutional investors like pension funds or hedge funds.
Surprisingly, there’s a growing number of ETFs in this space, and some are specifically tailored to generate above-average income. If you already have a yield-focused portfolio of dividend stocks, junk bonds, covered call ETFs, or REITs, these alternatives can make a powerful satellite allocation to diversify your sources of risk and yield.
Emphasis on satellite—many of these assets are exotic and come with unique risks. I wouldn’t recommend using them as a core holding, especially for beginners. That said, here’s a look at three ETFs I’d combine in equal weights to hunt for alternative yield.
1. Master Limited Partnerships (MLPs)
When you think of energy stocks, the first names that probably come to mind are integrated oil giants like ExxonMobil (NYSE:XOM), Chevron (NYSE:CVX), or Shell (NYSE:SHEL), or the more volatile explorers and producers like Marathon Petroleum (NYSE:MPC) and ConocoPhillips (NYSE:COP).
But there’s a lesser-known part of the energy sector worth considering: the midstream segment, represented by Master Limited Partnerships (MLPs).
MLPs are partnerships rather than traditional corporations, operating in the “midstream” part of the energy value chain. This means they’re primarily involved in transporting, storing, and processing oil and natural gas—activities that are less sensitive to commodity price swings compared to upstream exploration and production.
The key to MLPs’ appeal lies in their high free cash flow, derived from long-term contracts. This stable cash flow supports above-average and consistent distributions, making them attractive for income investors looking for a very underrepresented industry.
However, buying individual MLPs comes with a downside: the K-1 tax form. When you invest in an MLP, you’re treated as a partner, which means the partnership must send you a Schedule K-1 detailing your share of its income, deductions, and credits. While the form itself isn’t inherently problematic, it can complicate tax reporting.
If you want MLP exposure without dealing with K-1s, an ETF offers a smarter solution. A relatively affordable option is the Global X MLP ETF (NYSE:MLPA). It has a 0.45% expense ratio, which is 15% lower than the segment average, and is well-capitalized with $1.71 billion in assets under management. The fund holds 20 MLPs and generates a 6.83% 12-month trailing yield, all without the hassle of a K-1.
2. Business Development Companies (BDCs)
Thanks to firms like Apollo, we now have private credit ETFs, and private equity ETFs focusing on publicly listed firms have been around for some time. However, the longstanding way to access both private credit and private equity exposure has been through Business Development Companies (BDCs).
BDCs are publicly listed investment companies that provide capital to privately held companies, usually in the form of loans (private credit) or equity stakes (private equity).
They’re essentially bridges between investors and small- to mid-sized businesses that don’t have easy access to traditional financing or public markets. BDCs generate income through interest payments on loans and seek additional upside through equity investments in these privately held companies.
By law, BDCs are required to distribute at least 90% of their taxable income to shareholders to maintain their favorable tax status as regulated investment companies. This means they tend to offer high distribution yields, making them appealing to income-focused investors.
However, the BDC space varies significantly in terms of the types of companies they lend to or invest in, as well as management styles and risk tolerance. Because of this variability, it’s essential to diversify your exposure rather than relying on any single BDC.
For a well-capitalized option, consider the VanEck BDC Income ETF (NYSE:BIZD). It manages $1.3 billion in assets and currently pays a very high 10.89% 12-month trailing yield without the hassle of K-1 forms.
Don’t be alarmed by the seemingly sky-high 13.33% expense ratio. This number is primarily due to acquired fund fees and expenses—these are the pro-rata portion of the expenses charged by the underlying BDCs, not costs borne directly by the fund. The actual management fee is a modest 0.40%, with an additional 0.02% in other expenses.
3. Simplify Volatility Premium ETF (SVOL)
We’ve finally reached a point where ETFs can convert market volatility into income. It sounds complex—and it is—so bear with me for a moment.
The most successful example of this strategy is the Simplify Volatility Premium ETF (NYSE:SVOL). It’s one of the rare funds to earn a five-star Morningstar rating, meaning that on a risk-adjusted basis, it’s outperformed the vast majority of the 1,276 funds in the large blend category.
So, what does SVOL do? It generates returns that are approximately one-fifth to three-tenths (-0.2x to -0.3x) the inverse of the performance of the CBOE Volatility Index short-term futures index. In simple terms, it bets against short-term VIX futures.
Why does inversing short-term VIX futures generate income? Two main factors:
- Mean reversion: The VIX tends to revert to its average over time, so extreme spikes are often temporary.
- Contango: Short-term VIX futures generally trade at a premium to spot VIX prices, meaning they lose value as they approach expiration.
This isn’t the first time an ETF has tried to profit from shorting VIX futures, but it’s learned from past disasters like the 2018 "Volmageddon," when short-VIX ETFs imploded. SVOL has safeguards in place, including deep out-of-the-money (OTM) VIX call options. These options act as low-cost insurance against sudden, extreme spikes in volatility, reducing the blow if the VIX surges unexpectedly.
Most of SVOL’s holdings are in Treasury bills, which serve as collateral for its futures positions. This conservative collateral base adds a layer of stability to the fund.
Currently, SVOL is paying a high 16.26% 12-month trailing yield, but it comes with a 0.72% expense ratio, which is reasonable given the exotic and complex nature of the strategy.
Putting the Portfolio Together
As of December 9, combining 33.33% each of MLPA, BIZD, and SVOL into an alternative income portfolio would net you a 12.14% trailing 12-month yield, although tax efficiency isn’t the best.
That said, on a total return basis from May 13, 2021, to December 6, 2024, this combination has soundly beaten the S&P 500. The portfolio delivered a 14.29% total return compared to the index’s 13.25%, with a higher risk-adjusted return (Sharpe ratio of 0.81 versus 0.63).
Still, I wouldn’t use this trio as the core of my portfolio. This combination is much better suited as a satellite allocation if 1) income generation is your priority and 2) you are already diversified with stocks and bonds. It’s also somewhat pricey and complicated, so if low fees and simplicity are priorities for you, these ETFs might not cut it.
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