3 Unusual Income ETFs That May Be Just What You're Looking For

Are you looking for investment income, but have a very specific -- maybe even unusual -- income need? Don't give up hope of achieving it. The answer is out there. You just might have to hunt for it in a place you weren't expecting to find it.

That's through exchange-traded funds, by the way. While most ETFs are a predictable basket of familiar stocks, a handful of exchange-traded funds generate the kind of income you need, and do so in a way you like.

Here's a closer look at three somewhat unusual income ETFs that could be exactly what you're looking for. Oh, and the smartest way of balancing each of their unique risks and rewards may be owning a stake in all three.

iShares Core High Dividend ETF

Just as its name suggests, the iShares Core High Dividend ETF (HDV -0.16%) holds stocks with above-average dividends. Its top holdings right now include ExxonMobil, Verizon, and Johnson & Johnson, each supporting the fund's current dividend yield of around 3.1%.

Income investors will respect that figure, but may not be terribly impressed by it. There are certainly higher-yielding options out there. However, there are a couple of details to consider here.

The first of these details is simply that while the yield may not be sky high, this ETF's dividend payments have grown reliably. Its current quarterly payouts are roughly twice as much as the payments being made a little over 10 years ago. And, given the blue chip nature of its holdings, this pace of dividend growth is likely to last indefinitely.

The other detail to embrace? Although the fund's chief goal is finding and then holding good dividend payers, these stocks often end up outperforming the broad market anyway. BlackRock (parent to the iShares family of funds) reports that over the course of the past 50 years, high-yield stocks boast an average annual total gain of 12.6%, versus the S&P 500's (^GSPC -1.11%) average yearly gain of just under 11%. There's much to be said for simply leaving things alone and letting time do the heavy lifting.

The kicker: The iShares Core High Dividend ETF is very tax efficient. That's not something most investors consider when buying a fund or ETF. But simply owning a fund can create taxable events, even if you don't sell that fund in a particular tax year. Any net capital gains booked by a fund's manager are just passed along to investors. If this fund isn't held in a tax-protected account like an IRA, you may end up owing taxes on these gains. Usually these distributions are modest, but they can occasionally get uncomfortably big.

The iShares Core High Dividend ETF dramatically limits this possibility, though. In fact, it's never paid a capital gains distribution.

VanEck BDC Income ETF

While the iShares Core High Dividend ETF's yield is healthy and fair, you can do better. Assuming you already own a more basic dividend-minded fund, you can feasibly add something that's a bit riskier, but with a decidedly better dividend yield. That's the VanEck BDC Income ETF (BIZD 0.03%).

Never heard of it? If not, you're not alone. It's a bit off the beaten path, to say the least!

It's an interesting income-generating prospect all the same, currently yielding right around 10%.

The VanEck BDC Income ETF holds nothing but business development companies, or BDCs for short. These are organizations that trade just like conventional stocks. Their business, however, is providing capital to up-and-coming companies that usually aren't publicly traded. Usually, this capital comes in the form of a loan with above-average interest rates (reflecting their above-average risk). Sometimes, though, this money will be offered in exchange for equity in the company borrowing it.

However, these agreements are structured, the ultimate outcome is the same. That is, investors are plugged into opportunities that aren't directly available via any stock exchange. The only way to capitalize on most of these privately owned entities is through a BDC. By owning the VanEck BDC Income ETF, you don't even have to pick a particular business development company to invest in. MVIS and then VanEck do that work for you.

A word of warning here... the official expense ratio for the VanEck BDC Income ETF is an extremely high 11%. Don't freak out, though. That figure reflects a reporting requirement that's unique to business development companies, and any funds that may hold them. This ETF's actual effective management fee is a mere 0.4%.

Global X S&P 500 Covered Call ETF

Last but not least, income-minded investors may want to consider taking on a position in the Global X S&P 500 Covered Call ETF (XYLD -0.23%).

You've certainly heard of the SPDR S&P 500 ETF Trust (SPY -1.05%), or SPYders. Holding a piece of this fund is just an easy way to match the S&P 500's performance (rather than taking the big and often self-defeating risk of trying to beat it). This ETF, conversely, does not offer income to investors in the conventional sense by distributing dividends from the underlying stocks. It mostly just mirrors the broad market's ebb and flow, for better or worse.

So how does the ETF generate income? Like the SPYders, the Global X S&P 500 Covered Call ETF holds a cap-weighted stake in all the companies that make up the S&P 500. But unlike the SPDR S&P 500 ETF Trust, the Global X S&P 500 Covered Call ETF sells covered calls on those 500 stocks. This option-writing strategy generates repeatable income, which is then passed along to the fund's owners. More importantly, this income supports the fund's ongoing dividend payments, which consistently translate into a yield of right around 10% -- way higher than the dividend yield offered by the S&P 500 itself!

That's exciting to be sure. After all, the stock market's long-term average annual return is in the ballpark of 10% though that may not necessarily hold true on a year-to-year basis. However, with a covered call ETF mirroring the S&P 500, you're nearly matching that figure with this its reliable, recurring income. In short, this ETF removes the uncertainty in generating long-term market returns.

However there's a downside risk investors need to be aware of: this option-selling strategy ultimately leads to a subpar performance of the index fund's shares -- their net asset value, or NAV -- themselves. That's because selling covered calls sometimes means you're forced to sell the underlying stock below market prices.

Adding its dividend payments back into its shares' market-trailing gains pushes its performance back to near the S&P 500 index's net performance. The benefit to investors is simply the significant cash component of its market-matching results.