Preferreds Still Pertinent for Income Investors | ETF Trends

Low interest rates are prompting investors to seek out other income-generating assets beyond bonds. As a result, preferred stocks and the related exchange traded funds are receiving renewed attention in 2021.

Investors looking to access a broad basket of preferred stocks can turn to ETFs, including the Invesco Preferred ETF (PGX). PGX, one of the oldest funds in the preferred ETF category, tracks the ICE BofAML Core Plus Fixed Rate Preferred Securities Index. The allure of preferreds is easily explained. The asset class often performs well when interest rates are low, and it yields more than other income-generating assets.

“The $400 billion preferred-stock market offers yields of around 4% on new issues from banks and real estate investment trusts, while older securities with expected redemptions in the next few years yield 2% to 3%,” reports Andrew Bary for Barron’s.

PGX goes beyond that. The ETF has a trailing 12-month distribution rate of 4.88% and a 30-day SEC yield of 4.53%, according to issuer data.

Another reason preferred stocks are getting another look from income investors is the increasing financial sturdiness of banks. Financial services companies are the major issuers of preferred stock — PGX allocates nearly two-thirds of its weight to that sector. Amid the onset of the coronavirus pandemic last year, the Federal Reserve required banks to set aside cash for bad loans on the premise that a pandemic-related recession could be severe. However, the opposite proved true, and today, banks are repatriating that capital back onto their balance sheets.

For preferreds, there are positive factors like “the growing financial strength of banks, which are major issuers, and the light supply, especially relative to the corporate bond market, which has had an avalanche of issuance this year,” according to Barron’s.

The financial health of banks is relevant to preferred investors because preferred dividends must be paid. If an issuer misses a preferred dividend payment, that’s akin to missing a bond payment, and markets are apt to punish the issuer’s equity and debt as a result. Fortunately, default risk with PGX member firms appears low today, and that much is confirmed by the recent spate of new preferred issuance.

“Some $50 billion of new preferreds were issued in the first nine months of the year, but that has been nearly offset by redemptions,” reports Barron’s. “Preferred stock is a senior form of equity and its dividends are generally fixed, like the interest rate on bonds. For individuals, dividends on bank issues and most preferreds are taxed like common-stock dividends, at lower rates than interest in corporate debt.”

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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.