Long-time readers know that preferred stocks play an important role in my client portfolios. They reduce volatility and generate income. But with rock-bottom interest rates most preferreds are near their highs and trading above par.
A preferred is a “hybrid” security with characteristics of both common stocks and bonds. Most preferreds represent ownership in a company like common stock and rank senior to the common when it comes to dividends and in liquidation. They are junior to bonds, but pay dividends (usually quarterly) like bonds pay interest (semi-annually).
In anticipation of continued low interest rates, investors have pushed preferred prices toward their highs. The average preferred stock trades at $26.02, a full dollar above par value.
It’s getting harder to find attractive securities, but there are a few.
One way to pay less than par is to buy adjustable-rate issues. The Goldman Sachs Series ‘D’ (GS.D) and Morgan Stanley Series ‘A’ (MS.A) are paying their minimum payment of 4% of par ($25). Since they trade just above $22, their current yield is 4.5%. They pay qualified dividends and are rated BB and BB-plus, respectively.
AGNC Investment Corp is a mortgage REIT that has a 6.50% Fixed/Float Series ‘E’ (AGNCO). This preferred trades above par but can’t be called until October 2024. When its dividend floats in 2024 it will continue to have a good yield (three-month Libor plus 4.993%). At its current $25.50 price it yields 6.4%. That’s less than many other REIT preferreds but it is also safer than most.
The mortgages it holds are government guaranteed as to interest and principal. This security does not pay qualified dividends.
The main risk in these preferreds is rising interest rates. If the economy strengthens a lot, maybe after a trade deal is reached, then there would be upward pressure on interest rates. If rates rise then the yields listed above become less attractive so prices would decline.
Predicting interest rates is a frustrating exercise, which is why the smart investment approach is to have some exposure to assets that would do well if rates rise (equities) and some positions that would do well if they stay flat or fall (preferreds).
So a year ago when experts were sure that rates would rise, as seemed logical, I still chose to keep preferred stocks, exchange-traded debt, and even the much-maligned utilities (utilities are up 20% this year!). A balanced portfolio is the best approach.
David Vomund is an Incline Village-based Independent Investment Advisor. Information is found at www.VomundInvestments.com or by calling 775-832-8555. Clients hold the positions mentioned in this article. Past performance does not guarantee future results. Consult your financial advisor before purchasing any security.