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Alternative Income through Preferred SecuritiesCoulter Regal, CFA, Associate Product ManagerJanuary 12, 2021
In an ever-changing interest rate environment, keeping tabs on the numerous corners of the yield market can be difficult. To help investors stay informed, we offer monthly commentary on income investing, covering the latest news, trends and investment opportunities.
Entering into 2020, yields for many income producing securities were already low, as the second half of 2019 saw the first U.S. rate cuts in years to combat rising trade tension and slowing global growth. For many investors this reignited their search for yield. Now heading into 2021, that search continues as yields for most income producing assets ended 2020 even lower than where they stood one year ago. While additional stimulus payments and the vaccine rollout may help speed up the economic recovery, any substantial rate increases are unlikely in the near term and yield-starved investors will remain on the hunt for alternative income sources outside of traditional options.
Preferred securities are one alternative source of income that investors may want to consider when looking to enhance yield in their portfolios. Preferreds are considered hybrid securities, as they exhibit characteristics of both stocks and bonds, and can offer yield potential higher than that of a company’s common equity and senior debt. In addition to yield potential, preferred securities can also act as a useful diversifier in portfolios, especially during volatile periods, as they generally feature low correlations with equities and traditional fixed income instruments. The yield potential and diversification benefits of preferred securities has attracted investor attention of late. However, those interested in the space should be aware that a large majority of preferred securities are issued by banks and insurance companies, leading to an overconcentration of financials in the broad preferreds market.
To alleviate concerns of concentration risk, we believe investors should consider non-financial preferreds (“ex financials”), which provide a differentiated exposure to the space, resulting in greater sector diversification without sacrificing yield. In fact, ex financial preferreds have actually offered a yield pickup over the broad preferred market historically, and currently even out yield high-yield credit markets, despite about a third of the ex financials preferred market carrying an investment grade credit rating. Beyond sector diversification and a yield premium, ex financial preferreds also display a couple other notable features relative to financial preferreds or the broad-based universe. Excluding financial issuers also increases the proportion of preferreds paying cumulative distributions and lowers the proportion featuring near-term call dates relative to the broad preferreds market. These are important characteristics in today’s environment, where there are concerns of delayed or suspended payments and high incentive for issuers to call and reissue securities at lower rates.
The VanEck Vectors® Preferred Securities ex Financials ETF (PFXF) provides thoughtful exposure to the preferreds market by excluding traditional financial companies. This results in greater sector diversification without sacrificing yield, as well as lower call and payment risk relative to the broad preferreds market. The Fund’s 30-day SEC yield was 5.31%, as of December 31, and we view this strategy as a compelling option for investors searching for an alternative income source to enhance yield and diversification in their portfolio.
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.
An investment in the VanEck Vectors® Preferred Securities ex Financials ETF (PFXF) may be subject to risk which includes, among others, preferred securities, convertible securities, foreign securities, credit, interest rate, floating rate, floating rate LIBOR, subordinated obligations, investing in REITs, small- and medium-capitalization companies, real estate, utilities, communications, market, operational, call, index tracking, authorized participant concentration, no guarantee of active trading market, trading issues, passive management, fund shares trading, premium/discount risk and liquidity of fund shares, non-diversified and concentration risks, all of which may adversely affect the Fund. Small- and medium-capitalization companies may be subject to elevated risks.
Investing involves substantial risk and high volatility, including possible loss of principal. An investor should consider the investment objective, risks, charges and expenses of a Fund carefully before investing. To obtain a prospectus and summary prospectus, which contain this and other information, call 800.826.2333 or visit vaneck.com. Please read the prospectus and summary prospectus carefully before investing.
Authored byCoulter Regal, CFA
Associate Product Manager