Preferred Stocks Battered, but Opportunity Knocks

That is, until interest rates rise. Preferred stocks and the related exchange traded funds are, historically, rate-sensitive, and that much is on display this year as the widely followed ICE Exchange-Listed Preferred & Hybrid Securities Index is down 14.44%.

Plunging preferred prices mean higher yields. More importantly, there could be value available in this asset class, highlighting rebound potential with ETFs such as the American Century Quality Preferred ETF (QPFF).

“The preferred-stock market has suffered one of its worst selloffs in decades as yields on leading bank preferred issues have risen to about 6% from 4%. But with yields now at their highest levels in five years, the $350 billion market has gotten more attractive,” reports Andrew Bary for Barron’s.

While many of the largest established preferred ETFs on the market today are passive index-based funds, QPFF is actively managed — a methodology that has merit at a time when the market environment is proving hostile to preferred stocks.

For example, QPFF’s managers can more nimbly navigate rate risk — a primary consideration in this asset class — relative to passive rivals. Additionally, the American Century fund can more easily avoid preferred stocks that are the most egregious offenders in terms of price declines, and with the Federal Reserve boosting interest rates, there are plenty such preferred issues stumbling this year.

“Some preferred issues have fallen nearly 30% in price this year—a huge decline for an asset class many investors have viewed as relatively low risk. The losses reflect the rise in long-term interest rates and a widening in yield spreads relative to Treasuries. Most preferreds are perpetual, which can make them acutely sensitive to rate changes,” according to Barron’s.

However, with many preferreds trading below face value amid rising rates, QPFF could be a value opportunity. Additionally, credit quality is mostly strong across the preferred landscape. As an actively managed ETF, QPFF can seize upon both credit and value opportunities among preferred issues.

“Buying preferreds at discounts to their face value mitigates one of the problems with the market. Preferreds generally can be redeemed by issuers in five years, limiting their upside. But if an investor buys a preferred at a sharp discount, there is considerably more appreciation potential,” notes Barron’s.

QPFF, which is 15 months old, sports a 30-day SEC yield of 5.36%, according to issuer data.

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