The recent surge by Treasury yields is matriculating throughout the fixed income universe. It stokes higher yields on a slew of bond segments, including preferred stocks.
For example, the VanEck Preferred Securities ex Financials ETF (PFXF) sported a 30-day SEC yield of 7.97% as of Oct. 6. That elevated yield could signal opportunity with the exchange traded fund, which tracks the ICE Exchange-Listed Fixed & Adjustable Rate Non-Financial Preferred Securities Index.
Preferred stocks, including PFXF holdings, are what’s known as hybrid securities. This means that they display properties associated with both stocks and bonds. Preferreds typically sport higher yields than corporate debt, in some cases, even junk bonds. The dividends tied to this asset class are higher up on issuers’ priority list than common stock payouts, which implies a level of guarantee. If an issuer misses a preferred dividend payment, credit ratings are likely to suffer.
To be sure, that’s an alluring trait. Still, there are other reasons PFXF could reward fixed income investors heading into 2024.
PFXF Perks
One of the advantages of preferred stocks and ETFs such as PFXF is tax benefits not found with common stocks.
“Preferred dividends generally are taxed favorably, like those on common stock, at a maximum federal rate of 23.8% (including the Medicare surcharge), while corporate debt is taxed as ordinary income at a maximum federal rate of 37%,” reports Andrew Bary for Barron’s. “A 7.5% preferred yield is equivalent to more than 9% on a corporate bond. Investors would need to buy junk-grade corporate bonds to get similar after-tax yields on what is mostly an investment-grade preferred market.”
Specific to PFXF, the advantage is found in the fund’s name. The VanEck ETF doesn’t hold preferreds issued by banks – the largest issuers of preferred shares. That’s a potentially attractive attribute following stress in the regional banking space earlier this year. Additionally, auto loan and credit card delinquencies are flirting with levels not seen since the Global Financial Crisis.
In terms of performance, the exclusion of bank-issued preferred shares is playing out in favor of PFXF. The VanEck ETF is sporting a modest year-to-date gain while both the ICE Exchange-Listed Fixed & Adjustable Rate Preferred Securities Index and the ICE Exchange-Listed Preferred & Hybrid Securities Index are in the red this year.
Plus, issuers are displaying commitment to preferred dividends this year and issuance has been scant this year.
“Preferreds aren’t as safe as corporate debt, but problems have been isolated. Companies are loath to eliminate preferred dividends in part because common dividends can’t be paid if preferred dividends aren’t,” according to Barron’s.
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