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Likely in response to the end of the Federal Reserve’s tightening cycle and in anticipation of the first rate cuts (hopefully, next month), preferred stocks and the exchange traded funds holding those assets are enjoying decent performances this year.
The ICE Exchange-Listed Preferred & Hybrid Securities Index, a broad-based, widely observed gauge of preferreds, is up 5.6% year-to-date – a solid showing when considering the index lobs off a 30-day SEC yield of 6.32% and is comprised of 58% investment-grade fare.
Preferred stocks are considered hybrid securities because they possess both equity and fixed income traits. However, preferreds are more arguably more tied to bonds because some have long-dated maturities and the asset class is rate-sensitive. Those ties are also seen at the performance level. Over the past three years – a period including the Fed’s latest tightening campaign – the ICE Exchange-Listed Preferred & Hybrid Securities Index slid, though in significantly less worse fashion the Bloomberg U.S. Aggregate Bond Index.
Obviously, that’s in the past and there’s a growing sense among some market observers that preferreds can build on the aforementioned solid starts to 2024, but being selective is vital.
History Favors Preferred Stocks, Funds
As I often say in this space, history doesn’t always repeat, but it often rhymes. With that in mind, it’s worth noting post-rate history is often efficacious for preferreds.
“Looking back at the performance of preferreds during the last four rate hiking cycles, after interest rates peak, returns in the preferreds market have been strong for the next two years,” notes VanEck’s Coulter Regal. “On average preferreds have returned over 15% in the two years following the final rate hike of the cycle. This average return increases to over 20% if you exclude the 2005-2008 rate cycle which was impacted by the Global Financial Crisis. While past performance is not a predictor of future outcomes, this data provides a favorable historical foundation.”
It’s not just preferreds’ post-rate cut precedent that’s meaningful. Advisors should also examine performance following the last rate hike. Preferreds are living up to historical billing on that front in 2024.
“Since the last rate increase, in July 2023, the preferreds market is up a little more than 10%. While it is still early, this recent performance could be a sign of more positive returns in the months ahead, particularly if rate cuts do begin this year and the U.S. economy remains resilient,” adds Regal.
Yes, Preferreds Have Concentration Risk
Concentration risk is often discussed as it relates to equity benchmarks and funds, but it’s a consideration in the world of preferreds because the financial services sector accounts for a staggering percentage of preferred issues.
That leads to massive exposure to financial services preferreds in both active and passive strategies, but the VanEck Preferred Securities ex Financials ETF (PFXF) provides a compelling alternative – one that’s topped some rivals over extended holding periods.
“Beyond the obvious benefits of excluding financials in the current market, ex-financial preferreds generally also offer a number of other benefits over the broad preferreds market that investors might find attractive. Historically higher yield, greater sector diversification and strong relative performance compared to broad preferreds universe,” concludes Regal.
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