Traditional equity and fixed income yield and income are getting harder to source thanks to low interest and dividend cuts. Those scenarios highlight the allure of preferred stocks and exchange traded funds, including the Principal Spectrum Preferred Securities Active ETF (PREF).
As a high-yield asset class, preferreds historically perform well as interest rates decline. Rates are certainly faltering this year, but that also means yields on preferreds are declining. However, some market observers don’t see that as a mark against the asset class.
“Ranked above equity (without voting rights) and mainly issued by financials, preferred stocks have been a fantastic source of high current yield. Due to the lack of new issuance and the demand for higher yields, preferred stock valuations have risen over the years,” according to Citi Private Bank.
Pluses to PREF Stocks
Preferred stocks are a type of hybrid security that shows bond- and equity-like characteristics. The shares are issued by financial institutions, utilities, and telecom companies, among others. Within the securities hierarchy, preferreds are senior to common stocks but junior to corporate bonds. Additionally, preferred stocks issue dividends on a regular basis, but investors don’t usually enjoy capital appreciation on par with common shares
“However, with U.S. preferred yields averaging 4% and European yields, 5%, value still exists. In many instances, valuations of preferred shares are comparable with similarly rated high-yield bonds,” notes Citi.
Income investors have looked to preferred stock ETFs in their portfolios for a number of reasons. For instance, the asset class offers stable dividends, does not come with taxes on qualified dividends for those that fall into the 15% tax bracket or lower, is senior to common stocks in the event liquidation occurs, is less volatile than bonds and provides dividend payments before common shareholders.
There is more good news for investors considering PREF. The Principal ETF is actively managed, so it can avoid possible dividend offenders in the preferred space. Second, the outlook for preferred dividends is more positive than negative.
“We continue to feel comfortable moving down in capital structure for higher yields in preferreds. In our view, large banks have entered the current economic slowdown from a position of fundamental strength. Dodd-Frank and Basel III regulations have required banks to increase their capital base substantially. While common dividend cuts remain an area of concern for a few banks, we don’t believe preferred dividends are at risk,” according to Citi.