Rare Opportunity Beckons in Preferreds | ETF Trends

Not even four months into 2022, it’s safe to say that bond market participants are weary of hearing about rising interest rates.

The problem is that the Federal Reserve, to this point, has deployed just one rate increase — a modest 25 basis points. Markets are pricing in more intense rate hikes, perhaps as soon as the central bank’s May meeting. In other words, this is a trying fixed income environment.

Just a handful of fixed income exchange traded funds are higher since the start of 2022, and it’s easy to surmise that the group doesn’t include longer-duration, high-yield fare such as preferred stocks. Indeed, ETFs such as the American Century Quality Preferred ETF (QPFF) are sagging, but there is now rarely seen opportunity available with preferreds, according to some experts.

“For those willing to take a bit more risk to earn higher yields, preferred securities appear attractive. Prices have been hit hard by the double whammy of surging long-term Treasury yields and stock market volatility,” note Collin Martin and Cooper Howard of Charles Schwab. “However, aside from the pandemic-driven plunge in March 2020, average prices have rarely been lower, and the price plunge provides a relatively attractive entry point.”

QPFF has some notable advantages relative to more established ETFs in the preferred stock category. Namely, the American Century fund is actively managed, meaning it can better deal with interest rate risk — a concern with preferreds — better than an index-based equivalent.

QPFF could be an idea for income-hungry investors to consider not only because preferred valuations are attractive, but also because it’s possible that the bulk of the bond market’s declines may have already occurred.

“The bond market is forward-looking and yields tend to rise in anticipation of changes to the federal funds rate. We’ve already seen that happen, especially with two-year Treasury rates. If the markets are right and the Fed does hike rates to the 3.1% area, there’s not much more upside with short-term Treasury yields, especially compared with the recent rise,” add the Schwab analysts.

QPFF, which sports a 30-day SEC yield of 5.07%, has a duration of 2.55 years. That’s well below the 4.26 years found on the benchmark. The American Century ETF holds 125 preferred stocks, roughly a quarter of the roster size of the preferred stock benchmark. QPFF also has a larger percentage of its holdings rated investment-grade and fewer with no ratings than the benchmark.

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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.