How to Capitalize on Preferred Stock Strength, Limit Risk

Fueled in part by expectations that the Federal Reserve will lower interest rates this year — or at the very least, won’t hike anymore — preferred stocks and related ETFs are delivering solid showings for income investors.

For its part, the VanEck Preferred Securities ex Financials ETF (PFXF) is higher by nearly 4% year to date. That adds to performance that’s seen preferreds rank as among the best-performing fixed income assets dating back to Q4 2023.

For PFXF, that bullishness comes with the benefit of a 7.01% 30-day SEC yield. It also has no exposure to preferreds issued by financial services companies. The latter is a point to consider at a time when auto loan and credit delinquencies are at multiyear highs.

More Perks of the Preferred Securities ETF PFXF

Preferreds are considered hybrid securities. That means they possess both equity and fixed income traits. But they’re more frequently lumped in with bonds. That implies PFXF’s currently high yield could be enticing. That’s because the higher a bond’s yield is when an investor gets involved, the shorter the odds are of long-term upside.

“Yields have risen sharply over the past few years and the ICE BofA Fixed Rate Preferred Securities Index now offers an average yield-to-worst of more than 5.5%. That’s off its recent high of 7.8% from last fall. But it’s at the high end of the 10-year pre-pandemic range,” noted Collin Martin of Charles Schwab.

Speaking of yields, declines by 10-year Treasury yields could stoke further upside for preferred stocks. That’s important, because preferreds, including those held by PFXF, typically have longer maturities.

“We see fair value for the 10-year Treasury yield in the 3.5% to 4% area, compared with its current yield of roughly 4.2%. That suggests there is room for yields to move lower from here, which could boost preferred security prices,” added Martin.

PFXF’s aforementioned 30-day SEC yield is pertinent for another reason. As of late March, the yield on the ICE BofA Fixed Rate Preferred Securities Index was 6.3%, which as Martin pointed out, wasn’t much of an advantage over 5.5% yield of the Bloomberg U.S. Corporate “BBB” Bond Index. However, the VanEck ETF yields well in excess of both of those indexes.

PFXF’s yield advantage could be seen as a signal that the ETF will reward potentially higher risk relative to broader gauges of traditional investment-grade corporate debt.

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