In low interest rate environments, preferred stocks and the related exchange traded funds are among income investors’ favored destinations.
However, as is the case with multiple high-yield asset classes, preferreds are often vulnerable to rising interest rates — the very scenario that investors are contending with today. That doesn’t mean that yield-starved investors should outright ignore preferreds today. Thanks to the Invesco Variable Rate Preferred ETF (VRP), there’s a less rate-sensitive way to embrace preferreds as rates rise.
VRP follows the ICE Variable Rate Preferred & Hybrid Securities Index, which is home to floating-rate and variable-rate preferreds, which are the less rate-sensitive forms of preferred stocks. Another benefit of VRP is that preferred stocks may be offering value today.
“The average price of the ICE BofA Fixed Rate Preferred Securities Index is now roughly $96, well below its recent peak of $108 in July 2021. While the price plunge may spook investors that currently hold preferreds, we think the entry point is looking more attractive,” says Collin Martin of Charles Schwab. “Over the last 20 years, the average price of the index has rarely been lower than where it is today. There are two clear outliers: the 2008-2009 financial crisis and the pandemic-induced plunge in March 2020.”
VRP holds 311 preferred stocks and has an effective duration of 2.76 years, which is low relative to the category average, according to issuer data. That could prove advantageous for investors.
“The risk of higher long-term yields as the Fed continues to hike rates could mean preferred yields go up (and prices down). Also, geopolitical risks could result in a flight-to-safety, where investors shift to more conservative investments and out of riskier investments like preferreds. That could pull prices lower, as well,” adds Schwab’s Martin.
However, VRP’s variable-rate methodology may be just the recipe that income investors want against the backdrop of rising rates.
“But for those investors who can ride out the ups and down, preferred securities appear attractive. With an average yield-to-worst of roughly 5%, the ICE BofA Fixed Rate Preferred Securities Index offers higher yields than most fixed income investments today. We always suggest that investors consider preferreds as long-term investments given their long maturity dates, or no maturity dates at all,” concludes Martin.
Simply because the $2.01 billion VRP isn’t as sensitive to rising rates as its traditional rivals, that doesn’t mean it skimps on income, as highlighted by a 30-day SEC yield of 4.65%.
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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.