Count preferred stocks among the high-yield asset classes that are retreating amid the Federal Reserve’s recently commenced interest rate tightening program.
The widely followed ICE Exchange-Listed Preferred & Hybrid Securities Index is off 9.66% year-to-date, confirming the vulnerability of preferred stocks to rising interest rates. However, there’s a silver lining: Recent declines in the preferred equity space could be unveiling value, potentially giving investors reason to consider exchange traded funds such as the American Century Quality Preferred ETF (QPFF).
“The average price of the ICE BofA Fixed Rate Preferred Securities Index is now roughly $96, well below its recent peak of $108 in July 2021. While the price plunge may spook investors that currently hold preferreds, we think the entry point is looking more attractive,” notes Collin Martin of Charles Schwab. “Over the last 20 years, the average price of the index has rarely been lower than where it is today. There are two clear outliers: the 2008-2009 financial crisis and the pandemic-induced plunge in March 2020.”
QPFF, which recently turned a year old, offers income investors some perks in today’s rising rate environment. For example, the fund is actively managed, meaning that QPFF’s managers can better navigate credit and interest rate risks than can those of rival passive products.
QPFF “identifies issuers believed able to sustain dividends throughout the market cycle by emphasizing earnings quality and profitability while avoiding highly levered names with poor credit quality,” according to American Century.
QPFF’s ability to identify companies that can meet their preferred dividend obligations is vital because a missed preferred dividend payment is akin to a missed interest payment on corporate bonds — markets see it as a sign of financial duress, and the issuer is punished accordingly.
Adding to the value proposition with QPFF is the fact that preferreds have rarely started a year as poorly as they started 2022.
“The price decline has resulted in one of the worst starts to a calendar year for the ICE BofA Fixed Rate Preferred Securities Index—the index is down 7.9% through March 22nd. That’s the second worst start to a year since 2010, trailing only the 2020 pandemic-induced plunge when the index dropped more than 20% early in the year,” adds Martin.
That’s something to ponder when considering QPFF because preferreds share something in common with other fixed income instruments: Often, the lower a preferred stock’s starting price, the better an investor’s chances are of long-term upside.
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