The combination of low interest rates and rising equity prices could be the impetus for some investors to get involved with preferred stocks – an income-generating asset class with bond- and equity-like traits.
Preferreds are easily accessible with passive exchange traded funds, but it’s an asset class where active management can be beneficial to income investors. Enter the Virtus InfraCap U.S. Preferred Stock ETF (NYSEArca: PFFA).
As an active fund, PFFA can capitalize on valuation opportunities while focusing on companies with strong balance, ensuring preferred dividends aren’t risk. Those aren’t benefits found in most passive funds in this category and those perks are relevant at a time when some other corners of the bond market are expensive.
“Valuations for investment-grade and high-yield corporate bonds are expensive, and we prefer full benchmark allocations to these asset classes but without over-allocating to them. To support yield needs, we favor Preferred Securities,” according to Wells Fargo.
PFFA: Powerful Income Idea
The $416.75 million PFFA, which turned three years old last month, lives up to the yield hype having sported a yield of 8.48% at the end of the first quarter. However, there’s more to the PFFA story than just pure yield and many of the compelling chapters come by way of the fund being actively managed.
For example, preferred stocks being considered for inclusion in PFFA are evaluated on the basis of the company’s return on capital, historical profitability trends, the issuer’s ability to generate cash going forward, and its ability to access capital, if needed.
Additionally, PFFA usually features no or limited exposure to preferreds that are callable with negative yield-to-call ratios. Plus, the Virtus funds enhance the preferred income proposition by using options overlays – a strategy that’s not common with passive funds in this category.
As an actively managed fund, PFFA can also take advantage of factors specifically affecting preferreds rather than merely focusing on interest rates.
“Active managers benefited from overweighting securities that experienced revenue or price impacts from COVID-19 (i.e., real estate, energy, travel, and non-investment grade),” according to Virtus. “Investing in preferred stocks using active managers provides for an attractive opportunity because (i) interest rates remain low, (ii) credit-driven considerations remain, (iii) market dislocations persist, and (iv) preferred stocks trading well above par can be sold at gains and substituted for similar yielding securities.”
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.