A Preferred Route

With yields of 6% or more, preferred securities have become a popular choice for yield-hungry investors willing to expand beyond plain vanilla bonds. Yet the hybrid nature of these securities often leaves investors pondering which side of the portfolio to put them on.

“Some people think of preferred securities as an alternative investment that falls somewhere between equity and debt,” says William Scapell, manager of the Cohen & Steers Preferred Securities and Income Fund. “I tend to view them as part of a fixed-income allocation because they are more like a bond than anything else.”

Often called preferred stock, preferred securities have characteristics of both stocks and bonds. Like bonds, they are sold at par value, and their prices fluctuate with changes in interest rates or upgrades and downgrades to a company’s credit ratings. The dividends on these issues, which are usually paid quarterly, typically exceed what investors can get from a company’s common stock or straight bonds. That income is subject to taxes, of course, at either the favorable rate for qualified dividends or at ordinary income rates, depending on the security.

The securities also lie between stocks and bonds in a company’s capital structure. If the issuer goes bankrupt, the preferred shareholders stand ahead of common stockholders but behind senior debtholders in the payback line. A company running short on cash would stop the income spigot to common stockholders before ceasing payments to preferred stock shareholders. Senior debtholders would be the last to feel the pinch.

A Better Value Than Bonds

Scapell believes that even though preferred securities have been discovered by more people over the last few years, they remain one of the few values left among income-oriented investments. They have a yield advantage of about 4% over 10-year Treasury securities, well above the average 3% spread over the last 15 years. Their yield spreads over investment-grade bonds are also currently high by historical standards.

“In our view, the difference in current versus long-term historical yield spreads suggests that preferred securities are relatively cheap,” he says. “And that yield advantage offers a potentially higher cushion against rising rates.”

Source:  Marla Brill, Financial Advisor magazine

iShares S&P 500 US Preferred Stock Index Fund (PFF) and the PowerShares Preferred Portfolio (PGX) are components of the D2 Capital Management Multi-Asset Income Portfolio.

The information contained in this article does not constitute a recommendation, solicitation, or offer by D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

 

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