As investors await the Federal Reserve’s first rate cut, those seeking income may consider preferred securities, according to analysis from Bank of America. The assets, which yield about 6%, are a hybrid product that trades on an exchange like a stock but has a face value and payment income like a bond. When the value of preferred stock rises, the yield falls. Strategist Michael Youngworth said in an Aug. 6 note that preferred stocks have performed well in the weeks leading up to the past four rate-cutting cycles by the Federal Reserve. Those bonds with a fixed interest rate and a par value of $25 performed particularly well. The preferred stock also has a par value of $1,000. “When first screened, preferred stocks ranked among the best in cross-asset average returns, trailing only the S&P 500,” he said. “While risk asset returns typically cool off in the weeks following the Fed’s first rate cut, Preferred stocks are still performing well relative to peers, although they have underperformed along with stocks after the first rate cut in the September 2007 (global financial crisis) cycle (hard landing). The next two-day central bank meeting is on September 17. In July, Fed Chairman Powell said a rate cut in September was “on the table.” Economists expect the central bank to achieve a soft landing. Stable earnings and good credit quality UBS also currently finds certain preferred securities attractive. The list of companies is based on those with good fundamental credit quality, valuation and structure. “To mitigate interest rate and spread volatility, we favor preferred stocks that pay relatively high fixed coupons,” Frank Sileo, senior fixed income strategist at UBS, wrote in an Aug. 7 note. Here are some of the picks: Fixed interest rate name. Keep in mind that preferred shares usually have a call date, which is when the issuer can redeem them. These instruments also carry greater credit risk because investors in preferred securities are subordinated to bondholders if the issuer gets into trouble. Like many other fixed income instruments, preferred stocks have always enjoyed attractive yields. The ICE Bank of America Fixed-Rate Preferred Securities Index tracks the performance of fixed-rate preferred securities, with a worst-case yield of 5.86%. That’s above the 10-year average of 4.2%, said JR Humphreys, senior portfolio manager at Sheaff Brock Investment Advisors in Indianapolis. He noted that worst-case yield, which measures the lowest rate of return investors can expect to earn, is the best barometer for preferred stocks. He favors preferred stocks, which he owns in funds he manages. Humphreys said interest rate cuts would be a tailwind for the security. Additionally, the largest issuers are financial institutions and insurance companies, he said. “They have so much regulatory oversight, which adds a level of comfort,” he said. Tacking the Preferred Stock Market with ETFs For those who want to invest in preferred stocks, Humphreys recommends buying actively managed mutual funds or exchange-traded funds. “The preferred market is very inefficient,” he said. “It’s not like a stock where you can look at a set of parameters and get some type of valuation. Each preferred stock may have different dividend and callability features.” Here are some of the top picks for securities ETFs. If buying individual preferred stocks, it’s important to diversify across different issuers, Humphreys said. He also recommends buying discounted preferred shares on the secondary market. This is because as interest rate expectations fall, the value of the security should begin to rise. “If interest rates go down, the preferred stock ($25 face value) is going to go up a little bit, and at some point, even if rates continue to go down, it’s going to move sideways,” he said. “One day, it’s going to be called $25. “He said if you buy it at $20, it could go up to $25 and continue to go up a few points. “You can participate in a greater degree of yield decline/price increase,” he said. Richard Alt, CEO of Carnegie Investment Advisors in Pepper Pike, Ohio, also rarely gives priority to new stock issues because so many trade at a discount. That is, he only buys them for a small number of clients who need to increase their revenue. He noted that these assets trade in small volumes and are not typically included in large funds. The disadvantage of preferred stocks is that if the underlying company’s stock performs well, the security does not participate in the upside. Also, if a company goes bankrupt, bondholders have more rights than holders of preferred stock to demand payment, Alter said. Investors should also realize that the direction of interest rates and the economy is important to the performance of preferred stocks, he said. He noted that you should believe that interest rates will fall and the economy will not fall into recession. If those options are selected, he thinks the preferred stock could be a good asset for investors looking to cut coupons. “If you don’t care about the stock price and the company is stable, you’ll probably be fine,” Alt said.
These high-yielding assets tend to perform well during rate-cutting cycles | Real Time Headlines
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