Preferred Stocks Offer Opportunity, But Selectivity Is Key

Turmoil in the regional banking industry had a contagion effect. Count preferred stocks as among the victims – not surprising when considering banks are the largest issuers of these hybrid securities.

Over the past 90 days, the widely followed ICE Exchange-Listed Preferred & Hybrid Securities Index is off nearly 8%. Proving that methodology matters, the VanEck Preferred Securities ex Financials ETF (PFXF) is outperforming the ICE preferred index by 235 basis points over the past 90 days and is higher on a year-to-date basis while the benchmark is in the red.

As its name implies, PFXF doesn’t hold preferred stocks issued by banks. And as the above statistics imply, that methodology is working in favor of investors at a time when concerns about some banks’ ability to service obligations, including preferred dividends are increasing.

PFXF Pertinent Today

A strong case can be made that the $1.1 billion PFXF is less risky than its bank-heavy preferred ETF counterparts. However, that reduced risk doesn’t mean the fund’s income profile is reduced. A 30-day SEC yield of 6.79% confirms as much.

PFXF offers advantages, including the potential for reduced volatility should more bank failures spook markets. And it checks the box of selectivity – an important trait in the preferred space today.

“Our guidance is unchanged, but with some caveats. We continue to suggest a neutral allocation to preferreds, meaning investors can consider them if an investment in preferred securities is in line with their risk tolerance and investing time horizon,” according to Charles Schwab research. “Volatility is likely to remain elevated, however, and additional price declines are possible. While the entry point appears attractive for long-term investors, some caution is warranted over the short run.”

PFXF’s 2023 annualized volatility is nearly 300 basis points below that of the largest ETF in the preferred category. Over the past three years, those two ETFs had the same annualized volatility. But PFXF beat its larger rival by 840 basis points. That could speak to the point of selectivity with PFXF.

“Investors who hold individual preferreds should always look at the characteristics of any preferred security they are considering, and not just search for those with the highest yields. If a given security — preferred or otherwise — offers a significantly higher yield than what appear to be similar securities, there’s likely additional risk with that issue or issuer,” added Schwab.

Or investors make life easier by eschewing bank-issued preferreds and considering PFXF’s other perks.

For more news, information, and analysis, visit the Beyond Basic Beta Channel.