Variable Preferred ETF Offers Floating-Rate Note Alternative | ETF Trends

Historically, high-yield asset classes have been vulnerable to rising Treasury yields. That includes preferred stocks — a favored income destination.

That makes the current environment all the more tricky to navigate for income investors. Yields on government bonds are still low, but the Federal Reserve is poised to raise interest rates multiple times this year, potentially crimping high-yield assets in the process.

That’s likely one reason why many investors are turning to floating-rate notes and the related exchange traded funds. The Invesco Variable Rate Preferred ETF (VRP) provides investors with what is today a compelling combination of preferred stock income and floating-rate notes.

The $2.07 billion VRP, which turns eight years old in May, follows the ICE Variable Rate Preferred & Hybrid Securities Index. That index features “floating and variable rate investment grade and below investment grade U.S. dollar preferred stock,” according to Invesco.

With a 30-day SEC yield of 3.68%, VRP is a credible alternative to investment-grade floating-rate strategies. Speaking of credit quality, 39% of VRP’s 312 holdings carry junk rates, but that’s not a stumbling block for the fund.

“Analyzing the credit quality of the floating rate ETFs highlights their different investment strategies. Investment grade floating rate ETFs, as per their name, hold investment grade instruments. Senior loan ETFs invest primarily in B-rated debt, while variable preferred ETFs offer slightly better credit quality, despite higher yields,” says Nicolas Rabener of Factor Research.

Among the various forms of floating rate debt, variable preferreds are among the most correlated to stocks, but that’s not surprising, owing to the equity-like traits displayed by preferreds. Still, the broader spectrum of floating-rate assets, including variable-rate preferreds, aren’t highly correlated to stocks, indicating that VRP can offer some portfolio diversification.

“Senior loan and variable rate preferred ETFs feature high positive correlations to the S&P 500, which can be explained by underlying portfolios, ie below investment grade corporate bonds that behave similar to equity. If a company experiences corporate stress due to firm-specific or industry reasons, then this can easily spread to its bonds, loans, and preferred instruments,” adds Rabener.

While it’s been more volatile, VRP outperformed the largest floating-rate note, high-yield, and investment-grade corporate bond ETFs over the past three years. VRP also yields 118 basis points more than the widely followed Markit iBoxx USD Liquid Investment Grade Index.

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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.