With interest rates likely to remain low over the course of 2021, advisors and investors are scrambling to source higher of levels of income. Preferred stocks and exchange traded funds such as the VanEck Vectors Preferred Securities ex Financials ETF (PFXF) can help with that objective.
PFXF seeks to replicate as closely as possible, before fees and expenses, the price and yield performance of the Wells Fargo Hybrid and Preferred Securities ex Financials Index. The Index is intended to track the overall performance of U.S.-listed preferred securities excluding those with a financial sector classification, including securities that, in Wells Fargo Securities LLC’s judgment, are functionally equivalent to preferred securities such as convertible securities, depository preferred securities, and perpetual subordinated debt.
“Entering into 2020, yields for many income producing securities were already low, as the second half of 2019 saw the first U.S. rate cuts in years to combat rising trade tension and slowing global growth. For many investors this reignited their search for yield,” writes VanEck analyst Coulter Reagal. “Now heading into 2021, that search continues as yields for most income producing assets ended 2020 even lower than where they stood one year ago. While additional stimulus payments and the vaccine rollout may help speed up the economic recovery, any substantial rate increases are unlikely in the near term and yield-starved investors will remain on the hunt for alternative income sources outside of traditional options.”
Preferred Stock ETFs Certainly Have Their Perks
Preferred stocks are a type of hybrid security that show 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. Preferred stocks issue dividends regularly, but investors don’t usually enjoy capital appreciation on par with common shares.
As PFXF’s name implies, the fund excludes preferred stocks issued by financial services firms.
Preferred stocks also act like bonds. Par value is assigned on issue, and this price rises or falls based on interest rates. When interest rates go up, the par value of the shares is diminished, just like bonds. Some preferred shares even have a maturity date where the investors’ capital is returned. Finally, some preferred shares are callable, meaning the company can decide at any time to repurchase the shares (although usually at a premium).
“To alleviate concerns of concentration risk, we believe investors should consider non-financial preferreds (“ex financials”), which provide a differentiated exposure to the space, resulting in greater sector diversification without sacrificing yield,” says Reagal. “In fact, ex financial preferreds have actually offered a yield pickup over the broad preferred market historically, and currently even out yield high-yield credit markets, despite about a third of the ex financials preferred market carrying an investment grade credit rating.”
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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.