Preferred stocks and related exchange traded funds retreated along with other income-generating assets as U.S. yields spiked in response to the Federal Reserve’s tighter monetary policy, but the asset category may offer an attractive buying opportunity after the pullback.
“Preferred stocks have recently underperformed given their sensitivity to higher interest rates,” according to a BlackRock research note. “The sector now offers more attractive risk-adjusted opportunities after this period of weakness.”
For instance, the iShares U.S. Preferred Stock ETF (NYSEArca: PFF) has dipped 1.5% since the presidential elections as yields on benchmark 10-year Treasury notes jumped as high as 2.597%.
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 preferred stocks provide investors with an attractive source of yields, the assets are vulnerable in a rising interest rate environment. If rates rise, the holdings must decline in price to elevate their yield to attractive levels. Furthermore, most preferred stocks are either perpetual or long-dated, which exposes investors to significant interest-rate risk.
However, despite the Fed’s plans to hike interest rates three more times this year, we may still be in for an extended low-rate environment as many risks could keep a lid on yields and support safe-haven demand for fixed-income assets.
“We believe there are many competing forces at work and the path forward remains positive, yet murky,” BlackRock said.
Specifically, some factors that could throw a wrench into global economy include a potential slowdown in China, elevated prices across many asset classes and uncertainty surrounding the Trump administration’s ability to enact the initiatives the President-elect has promised.
“Weigh all of these factors and we still find ourselves late in economic expansion where income continues to be a dominant driver of return and elevated valuations will likely lead to moderate price appreciation,” BlackRock said. “Additionally, we expect more frequent spikes in volatility and a greater dispersion between winners and losers that could create attractive buying opportunities.”
Investors who are focusing on income generation can take a look at a number of preferred stock ETF options to bolster yields, including the PowerShares Preferred Portfolio (NYSEArca: PGX), Global X SuperIncome Preferred ETF (NYSEArca: SPFF), First Trust Preferred Securities and Income ETF (NYSEArca: FPE) and SPDR Wells Fargo Preferred Stock ETF (NYSEArca: PSK).
Alternatively, investors may also consider the PowerShares Variable Rate Preferred Portfolio Fund (NYSEArca: VRP) in a rising rate environment. Variable-rate preferreds usually trade more like bonds with shorter durations, so more conservative investors may find the lower-risk profile more appealing.
For more information on preferreds, visit our preferred stock category.