As advisors and investors look beyond U.S. Treasuries for income, some other yield-bearing asset classes are getting renewed attention, including preferred stocks. The actively managed Principal Spectrum Preferred Securities Active ETF (CBOE: PREF) is part of that conversation.
Understanding the allure of preferreds in today’s low-yield environment isn’t difficult. For its part, PREF yields 4.82%. That’s more than investors get with Treasuries or investment-grade corporate bonds and the fund is a less volatile bet than some high dividend funds and stocks.
“Preferred shares have made a comeback since the stock market’s turmoil in March, and now offer attractive yields of about 5% from a range of issuers,” reports Andrew Bary for Barron’s. “These yields are historically high, relative to those of U.S. Treasuries. The yield gap of about 3.5 percentage points between preferreds and Treasuries has moved out a percentage point this year.”
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.
Making PREF all the more compelling are the tax breaks associated with preferred stocks.
“Most preferred dividends—with the exception of those paid by REITs—get the same favorable federal tax treatment as common dividends, with a top rate of 20%. This can make preferreds an alternative to municipal bonds, now with ultralow yields,” according to Barron’s.
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.
“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.”
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