Investors who are seeking yield generation opportunities should consider the benefits of incorporating preferred securities and related exchange traded funds into a traditional income portfolio.
In the recent webcast, How Preferred Securities can offer attractive yield and risk management, Seema Shah, managing director and chief strategist at Principal Global Investors; Matthew Cohen, head of ETF specialist team at Principal Global Investors; and James Hodapp, senior vice president and portfolio specialist at Spectrum Asset Management, underscored the struggles in the fixed income market environment that remain choppy, and how investors are looking for ways to diversify their yield-generation capabilities. Consequently, more are considering alternative income strategies, such as preferred stocks, which offer consistent income and could help manage risk.
The global economy is under stress as elevated commodity prices, notably soaring energy costs, have contributed to heightened inflationary pressures. While U.S. consumers have seen their energy costs rise, Europe is facing a much harsher winter ahead in face of the surging heating costs.
Nevertheless, the strategists warned that the U.S. economy faces a more brittle outlook ahead with households and companies struggling under the weight of ongoing inflationary pressures. The strategists predict that while inflation may have peaked already, inflation will remain relentless and stay uncomfortably high, further fueling uncertainty in the Federal Reserve’s monetary policy trajectory.
The Fed has already hiked interest rates as much in four months as it did in three years between 2015 to 2018. Additionally, we are likely to see another 75 basis point interest rate hike in the upcoming meeting with inflation stubbornly high as Fed officials are seeking price stability above all else, even at the cost of economic weakness.
Consequently, the strategists warned that financial conditions will continue to tighten, with equity and credit markets likely facing considerable further strain.
In this type of environment, investors may consider something like the Principal Spectrum Preferred Securities Active ETF (NYSEArca: PREF), which can act as a portfolio diversification tool and correlation reducer. Another advantage of PREF’s active management is that the managers can take advantage of value opportunities in an asset class that has been expanded over the past few years. Lack of constraint to an index is a relevant advantage because PREF’s managers can eschew issuers with shaky financial profiles while focusing on those most likely to make good on dividend payments.
Preferred securities’ risk profile also looks more like investment-grade credit based on their default rates. Consequently, preferreds offer a comparable yield to speculative-grade debt but with less credit risk than high-yield bonds. Among Morningstar peer groups, preferreds offer competitive yield relative to risk.
Furthermore, Spectrum targets credit quality through a top-down and bottom-up process that scores relative credit quality to reduce credit risk. The firm actively manages towards lower aggregate call risk on preferred securities by reducing exposure to overpriced call options that can lead to negative yield horizons. Lastly, they focus on securities with adjustable-rate coupons and high forward reset spreads, where negative convexity is a significantly lesser risk, to help better manage interest rate risk.
Investors will commonly target high-quality, institutional $1,000 par preferred securities when investing in the Principal Spectrum Preferred Securities Active ETF. The ETF seeks to enhance risk/return profiles by complementing high-yield exposure and delivering tax-advantaged income potential by complementing muni exposure.
Financial advisors who are interested in learning more about preferred securities can watch the webcast here on demand.