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Financial Industry Insights from Advisors Asset Management
On June 14, 2022
3 Reasons to Consider Preferreds When Rates Are Rising
KEY TAKEAWAYS
Preferred securities historically have had significant yield advantages over other types of investment-grade fixed income such as corporate and municipal bonds (Exhibit 1). That remains the case after this year’s broad market repricing (yields have been pushed higher across fixed income, and now reflect a good deal of negative expectations in our view).
Preferreds’ extra yield can potentially help cushion some of the impact of rising interest rates on total returns. We believe that the above-average yields and modest durations (due to widely available securities with fixed-to-reset coupon features) on many preferreds could be an attractive combination in today’s environment. As well, preferreds can offer qualified dividend income (QDI) tax advantages.
Looking more closely at preferreds vs. high yield bonds, yields on investment-grade preferreds appear attractive relative to high-yield debt on a historical basis; high yield now only offers about 140 basis points (bps) of income over preferreds, compared with a long-term average of 209bps (Exhibit 2). While the spread has been tighter in recent years, the quality of preferreds is triple B on average (based on the domestic preferred market as of April 2022), which is five notches above the single B+ rating of high yield. As such, preferreds appear better positioned than high yield to help mitigate any slowdown caused by rising rates.
Yields on preferred securities appear attractive vs. high-yield bonds on a historical basis
3. Rates are rising but banks are in good shape
While the Federal Reserve’s rate increases could drive down economic growth, banks — the main issuers of preferred securities — are operating from a position of strength. For U.S. banks, core capital ratios, which measure the amount of non-preferred equity capital relative to risk-weighted assets, are close to 11% on average, which is well above required minimums, and much higher than the 7% average going into the 2008 financial crisis (Exhibit 3). The story is similar in Europe.
CRN: 2022-0613-10106 R
The opinions and views of this commentary are that of Cohen & Steers and are not necessarily that of Advisors Asset Management.
This material should not be relied upon as investment advice, does not constitute a recommendation to buy or sell a security or other investment and is not intended to predict or depict performance of any investment. This material is not being provided in a fiduciary capacity and is not intended to recommend any investment policy or investment strategy or take into account the specific objectives or circumstances of any investor. Please consult with your investment, tax or legal professional regarding your individual circumstances prior to investing.
Risks of investing in preferred securities. An investment in a preferred strategy is subject to investment risk, including the possible loss of the entire principal amount that you invest. The value of these securities, like other investments, may move up or down, sometimes rapidly and unpredictably. Our preferred strategies may invest in below-investment-grade securities and unrated securities judged to be below investment-grade by the Advisor. Below-investment-grade securities or equivalent unrated
securities generally involve greater volatility of price and risk of loss of income and principal, and may be more susceptible to real or perceived adverse economic and competitive industry conditions than higher-grade securities. The strategies’ benchmarks do not contain below investment-grade securities.
Duration Risk. Duration is a mathematical calculation of the average life of a fixed-income or preferred security that serves as a measure of the security’s price risk to changes in interest rates (or yields).Securities with longer durations tend to be more sensitive to interest rate (or yield) changes than securities with shorter durations. Duration differs from maturity in that it considers potential changes to interest rates, and a security’s coupon payments, yield, price and par value and call features, in addition to the amount of time until the security matures. Various techniques may be used to shorten or lengthen the Fund’s duration. The duration of a security will be expected to change over time with changes in market factors and time to maturity.
Cohen & Steers Capital Management, Inc. (Cohen & Steers) is a registered investment advisory firm that provides investment management services to corporate retirement, public and union retirement plans, endowments, foundations and mutual funds. Cohen & Steers U.S. registered open-end funds are distributed by Cohen & Steers Securities, LLC, and are available only to U.S. residents.
This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.
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