As we look for ways to pad our fixed-income portfolios in a lower-for-longer interest rate environment, investors can look to preferreds-related exchange traded funds for more attractive yield-generating opportunities.
“As core sectors of the bond market have been bid up by the Fed’s intervention, opportunities within fixed income have presented themselves within ‘non-core’ segments of the market. In our view, one asset class that still appears particularly attractive on a relative risk-return basis is preferreds,” Shaun Peters, Investment Research Manager- UIT, Invesco; and Brian McMullen, Fixed Income ETF Strategist, Invesco, said in a research note.
The strategists explained that as a whole, the preferred market has not directly benefited from Fed support and may still offer an opportunity to capture additional spread over Treasuries, relative to other fixed income sectors and asset classes.
Preferreds were also only one of two categories paying over 5% current yield as of mid-September, which may be especially attractive given today’s low rate environment. High yield was the other category that paid over 5% current yield, but preferreds show an attractive yield level with an investment grade rating on average.
In addition to attractive yields and valuation, the overall credit health of the preferred market is still robust. Banks and financial institutions make up the bulk of the preferred market, and these companies use preferred issuance to improve capital ratios and preserve financial flexibility.
“Large US banks have taken steps to ensure financial strength during the pandemic, including suspending all share repurchases. While bank earnings are expected to remain challenged until the economy reaches a stable footing, we believe bank preferreds will be supported by strong credit fundamentals and offer steady distribution income,” the strategists said.
“Looking outside banking and financial services, we also see opportunities for a diversified preferred portfolio to take advantage of the still-reasonable prices of preferred securities,” they added.
Investors who are interested in the preferreds category can look to ETF strategies to capture this market segment. For example, the Invesco Preferred ETF (PGX), one of the oldest ETFs dedicated to this asset category, is based on The ICE BofAML Core Plus Fixed Rate Preferred Securities Index. The Fund will normally invest at least 80% of its total assets in fixed rate US dollar-denominated preferred securities that comprise the Index. The Index tracks the performance of fixed rate US dollar-denominated preferred securities issued in the US domestic market. (Securities must be rated at least B3, based on an average of three leading ratings agencies: Moody’s, S&P and Fitch) and must have an investment-grade country risk profile (based on an average of Moody’s, S&P and Fitch foreign currency long-term sovereign debt ratings).
Investors can also look to the Invesco Financial Preferred ETF (NYSEArca: PGF) to gain exposure to preferred securities with either fixed or floating rate dividends issued by financial institutions. PGF is based on the Wells Fargo Hybrid and Preferred Securities Financial Index. The Fund generally will invest at least 90% of its total assets in preferred securities of financial institutions that comprise the Index. The Index is a market capitalization weighted index designed to track the performance of preferred securities traded in the US market by financial institutions. The Index is composed of preferred securities with either fixed or floating rate dividends issued by financial institutions that have received an industrial sector classification of “financial” from the Bloomberg Professional Service.
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