With Treasury yields still low and dividend cutting running rampant within the S&P 500, advisors and investors are scrambling to source income. Preferred stocks are one way of making that happen and investors can gain an added advantage with active management via the Principal Spectrum Preferred Securities Active ETF (CBOE: PREF).
Preferred stocks are a type of hybrid security that shows bond- and equity-like characteristics. The shares are issued by financial institutions, utilities, and telecom companies, among others. Within the securities hierarchy, preferreds are senior to common stocks but junior to corporate bonds. Additionally, preferred stocks issue dividends on a regular basis, but investors don’t usually enjoy capital appreciation on par with common shares.
“After massive selling in March and then a near full recovery in April, the average investment-grade preferred now yields 5.8% and others yield 8% or more. Now that they have rallied back it’s harder to find attractive securities,” according to the Tahoe Daily Tribune.
Without the constraints of an index, PREF’s management team can unearth value in today’s preferred stock climate.
PREF Wins For Income Investors
“Under normal circumstances, the fund invests at least 80% of its net assets, plus any borrowings for investment purposes, in preferred securities at the time of purchase,” according to Principal. “Examples of preferred securities include preferred stock, certain depositary receipts, and various types of junior subordinated debt (such debt generally includes the contractual ability to defer payment of interest without accelerating an immediate default event). It concentrates its investments (invests more than 25% of its net assets) in securities in one or more industries within the financial services sector.”
Like common stock, preferred stock is issued by a company and traded on an exchange. Preferred stock prices can fluctuate, but most of the returns from preferred stock come from dividends. Unlike common stock, preferred stock dividends are predetermined and paid at regular intervals. These dividends are paid in full before any dividends are released to common stockholders.
Preferreds are sensitive to interest rates, which is to say higher rates would hinder the asset class. Fortunately, the Federal Reserve appears unlikely to tighten borrowing costs anytime soon and probably won’t for a couple of years if not longer.
“Predicting interest rates is a frustrating exercise, which is why the smart investment approach is to have some exposure to assets that would do well if rates rise (equities) and some positions that would do well if they stay flat or fall (preferreds),” according to the Tahoe Daily Tribue.
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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.