As investors anticipate the Federal Reserve lowering interest rates, perhaps by as much as 50 basis points this year, some income-generating asset classes are receiving renewed attention. Preferred stocks and exchange traded funds, such as the Global X U.S. Preferred ETF (PFFD), are part of that mix.
Preferred stocks are a type of hybrid security that show 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.
“While typically increased risk is associated with higher expected returns, the bond market has demonstrated the opposite move,” said Global X in a recent note. “Investment grade and high yield bonds are showing lower spreads up US Treasuries than their historical average, indicting a smaller risk premium for taking on their credit risk.”
Spy on Spreads
The $348.5 million PFFD has a 30-day SEC yield of 5.61%, well above what investors find on investment-grade corporate bonds or the related ETFs. Nearly 87% of the fund’s 237 holdings are rated between BB- or BBB+ indicating those holdings mostly reside around the higher end of junk territory or the lower end of investment-grade.
“Preferreds, on the other hand, currently look more appealing as spreads are more in line with their historical averages,” according to Global X. “While high yield debt has spreads that are 133 basis points lower than their long term average, and investment grade debt is 36 basis points lower, preferreds are virtually in-line with historical figures. This shows that they are more fairly priced based on historical data than traditional corporate debt that looks expensive.”
Spreads and interest rate scenarios indicate now may be the appropriate time for investors to consider paring investment-grade corporate debt exposure in favor of preferreds and funds like PFFD.
“Particularly when compared to corporate debt, we believe now may be the time to rotate money away from the more traditional portions of the fixed income market and into preferreds,” said Global X.
PFFD charges just 0.23% per year, or $23 on a $10,000 investment, making it one of the least expensive preferred ETFs on the market.
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