Fears around the banking system following the recent collapse of U.S. regional banks, like Silicon Valley Bank, and the fall of Switzerland’s Credit Suisse has left many investors rushing to reconsider exposure to the financial sector in their portfolios. Preferred securities are one area of the market that investors should be mindful of as they are known for significant financial sector concentration, particularly in banks.
Those looking to keep the income potential and portfolio diversification benefits of preferreds while avoiding bank exposure should consider the VanEck Preferred Securities ex Financials ETF (PFXF). PFXF offers investors assess to the U.S.-listed preferred securities market while excluding banks and other financial issuers.
Banks Dominate the Preferreds Market
Following the financial crisis in 2008, banks and other financial institutions began issuing a significant amount of preferred stock to meet the higher capital levels required by regulators. This proliferation of preferreds issuance by financials resulted in the sector’s concentration, which now makes up over 75% of the U.S. preferreds market. Drilling down even further, the Banking Industry is specifically responsible for about half of this financial concentration, with the remainder being financial services and insurance companies1. This high concentration has become a glaring risk for investors in light of the current events regarding bank failures and possible contagion.
Broad U.S. Preferreds by Sector
Broad U.S. Preferreds by Industry
Source: ICE Data Indices. Broad U.S. Preferreds market represented by the ICE Exchange-Listed Fixed & Adjustable Rate Preferred Securities Index (PFAR). As of 2/28/2023.
Volatility in Financials Could Continue
While the current banking crisis has been somewhat stabilized, for the time being at least, by a central bank and government backstops, questions still remain. Concerns weighing on investor minds’ includes possible further contagion, the health of the broader banking industry both domestically and globally, and perhaps even the viability of fractional reserve banking as a system in the modern day where depositors can easily move money with just a few taps on their phone. Because of these uncertainties around the recent bank failures, volatility in financial names has been extreme the last few weeks and could remain elevated.
For preferred security investors looking to avoid some of this volatility, a potential solution is to simply avoid preferreds issued by companies operating in the financial sector. Expectedly, ex-financials preferreds have held up better in this volatile period than the broader financial heavy preferreds universe.
Preferreds Performance in a Turbulent March
As of 3/21/2023
Source: ICE Data Indices. As of 3/21/2023. Ex Financial U.S. Preferreds market represented by the ICE Exchange-Listed Fixed & Adjustable Rate Non-Financial Preferred Securities Index (PFAN). Broad U.S. Preferreds market represented by the ICE Exchange-Listed Fixed & Adjustable Rate Preferred Securities Index (PFAR). Financial U.S. Preferreds market represented by the ICE Exchange-Listed Fixed Rate Financial Preferred Securities Index (PFAF).
Is Call Risk Next on The Horizon?
While the current banking crisis is rightly top of mind for many, there may be another risk just on the horizon that investors may also want to keep their eyes on – call risk. Many preferred securities feature a call provision allowing an issuer to redeem its preferreds at or near par value prior to maturity. This means that if rates fall, issuers may choose to call their preferreds and issue a new series at more favorable rates. This could be problematic for investors as it can result in 1) lower yields (i.e., reinvesting at lower rates than the called issue) and 2) risk of loss if the issues were purchased at a premium to the call price.
In the near-zero interest rate environment over the last decade, call risk was not much of a problem as issuers hardly had any incentive to call back their securities. However, now that we find ourselves in a more normalized rate environment with yields around 5%, call risk could begin to remerge as new debt is issued at higher rates.
One of the benefits of ex-financial preferreds is lower call risk. This is because preferred securities issued by financial companies tend to include a callable feature more often than those from other issuers. In fact, nearly 100% of preferred securities issued by financial companies are callable, while only about 70% of the preferreds in the ex-financials universe are callable2. While exposure to callable securities is not completely removed in ex-financial preferreds, a notable reduction in call risk could help mitigate some of the impacts of any future call events.
Access to Preferreds Without the Financials
Those looking to keep the income potential and portfolio diversification benefits of preferreds while also avoiding bank exposure should consider the VanEck Preferred Securities ex Financials ETF (PFXF). PFXF offers investors assess to the U.S.-listed preferred securities market that excludes securities issued by financials, which many might find particularly attractive given the current banking crisis.
Beyond the obvious benefits of excluding financials in the current market, ex-financial preferreds generally also offer a number of other benefits over the broad preferreds market that investors might find beneficial. Higher yields historically, lower call risk, fewer long-dated and perpetual issues (i.e., lower duration), and greater sector diversification are a few of these benefits.
| Ex Financial U.S. Preferreds |
Broad U.S. Preferreds |
Financial U.S. Preferreds |
|
| Current Yield | 6.81% | 5.82% | 6.03% |
| Callable % | 71.3% | 99.7% | 100% |
| Effective Duration | 4.04 | 6.82 | 6.88 |
| Perpetual % | 43.8% | 71.8% | 100% |
Source: ICE Data Indices; FactSet. As of 2/28/2023. Ex Financial U.S. Preferreds market represented by the ICE Exchange-Listed Fixed & Adjustable Rate Non-Financial Preferred Securities Index (PFAN). Broad U.S. Preferreds market represented by the ICE Exchange-Listed Fixed & Adjustable Rate Preferred Securities Index (PFAR). Financial U.S. Preferreds market represented by the ICE Exchange-Listed Fixed Rate Financial Preferred Securities Index (PFAF).
The VanEck Preferred Securities ex Financials ETF (PFXF) seeks to replicate as closely as possible, before fees and expenses, the price and yield performance of the ICE Exchange-Listed Fixed & Adjustable Rate Non-Financial Preferred Securities Index (PFAN), which is intended to track the overall performance of U.S. exchange-listed hybrid debt, preferred stock and convertible preferred stock issued by non-financial corporations.
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Originally published 29 March 2023.
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IMPORTANT DISCLOSURE
1 Source: ICE Data Indices. As of 2/28/2023. U.S. Preferreds market represented by the ICE Exchange-Listed Fixed & Adjustable Rate Preferred Securities Index (PFAR).
2 Source: ICE Data Indices. As of 12/31/2022. Financial Preferreds market represented by the ICE Exchange-Listed Fixed Rate Financial Preferred Securities Index (PFAF). Ex Financial Preferreds market represented by the ICE Exchange-Listed Fixed & Adjustable Rate Non-Financial Preferred Securities Index (PFAN).
This is not an offer to buy or sell, or a solicitation of any offer to buy or sell any of the securities mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results, are valid as of the date of this communication and subject to change without notice. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. The information herein represents the opinion of the author(s), but not necessarily those of VanEck.
ICE Exchange-Listed Fixed & Adjustable Rate Non-Financial Preferred Securities Index (PFAN) is a rules-based index designed to track the overall performance of exchange-listed U.S. dollar denominated hybrid debt, preferred stock and convertible preferred stock publicly issued by non-financial corporations in the U.S. domestic market.
ICE Exchange-Listed Fixed & Adjustable Rate Preferred Securities Index (PFAR) is a rules-based index designed to track the overall performance of fixed and floating rate U.S. dollar denominated preferred securities issued in the US domestic market.
ICE Exchange-Listed Fixed Rate Financial Preferred Securities Index (PFAF) is a rules-based index designed to track the overall performance of fixed rate U.S. dollar denominated preferred securities issued in the U.S. domestic market by financial companies.
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