There are some income-generating asset classes where active management can favor investors. Preferred stocks could be one. Enter the Principal Spectrum Preferred Securities Active ETF (CBOE: PREF).
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 tempt when it comes to yield. For its part, PREF yields 4.76%, but there are some risks to consider with this asset class, many of which aren’t adequately addressed by index-based strategies.
“One objection heard often is that a company would only issue preferred shares if they have trouble accessing other capital-raising options,” according to Forbes. “It is generally cheaper for a company to issue a bond because interest payments on bonds are contractually guaranteed, and debt is senior to preferred stocks in a bankruptcy.”
PREF’s Active Advantage
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.
“Therefore, a corporate treasurer would only resort to issuing preferreds if the company wants to have the flexibility to suspend dividend payments, finds it difficult to find buyers for its debt, cannot find buyers for lower-dividend common stock, or would suffer a credit downgrade if additional debt obligations were added to its balance sheet. None of these alternatives is exactly reassuring” reports Forbes.
As an actively managed fund, PREF can avoid financially challenged companies that issuing preferred stock to fund other areas of the business, which can signal distress down the road.
Another benefit of PREF is that its managers can move to buy preferreds as issuers’ outlooks improve, participating in some of the upside offered by preferreds, an endeavor that’s often tricky for ordinary investors.
PREF is beating the widely followed ICE Exchange-Listed Preferred & Hybrid Securities Index by nearly 300 basis points this year.
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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.