With yields on U.S. government debt declining, junk bond yields doing the same, and plenty of companies paring dividends, alternative income strategies are of elevated importance in today’s environment. So is being active with the strategies. Enter the Principal Spectrum Preferred Securities Active ETF (CBOE: PREF).

PREF offers high monthly income by targeting preferred securities that have historically offered higher yields than similarly rated bonds, allowing for a solution to diversify income streams. Preferred securities may also pay qualified dividends, which are taxed at a lower rate than ordinary income.

Preferred stock “dividend payments issued in relation to them are the focus of these types of stocks (as opposed to stock price growth) and, while they aren’t technically a legal loan obligation in the same sense that interest payments on bonds are, preferred stockholders’ dividends are generally prioritized over any dividends that common stockholders might expect to receive,” reports James Brumley.

PREF Perks

Preferred stock is a class of equity security that typically pay fixed or floating dividends to investors and have “preference” over common stock, but they are subordinated to bonds. The issuing company must pay dividends to preferred stockholders before common stockholders, and in the event of a bankruptcy or liquidation of the company’s assets, must put the claims of the preferred stockholders ahead of the claims of the common stockholders.

“If a company is forced for some reason to suspend dividend payments to investors (including preferred shareholders), that company generally tries to eventually make up for preferred stockholders’ missed payments (which it wouldn’t do for common stock owners). This makes the dividend payment somewhat more secure for preferred shareholders,” writes Brumley.

That’s meaningful at a time when a slew of S&P 500 members slashed or suspended dividends in the first half of 2020.

Data also indicate active management, such as what PREF offers, can benefit preferred equity investors over the long haul because many passive preferred ETFs lag the Morningstar Preferred Stock Category over long holding periods.

“The downside? Preferred shareholders don’t get to participate in stock price appreciation the same way a common shareholder would as the price doesn’t fluctuate as much. It might be worth it, though, given their superior payouts,” according to Brumley.

PREF currently yields 4.79%.

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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.