1. Preferreds offer some of the highest yields in investment-grade fixed income

Preferred securities historically have had significant yield advantages over other types of investment-grade fixed income securities 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 is an attractive combination in today’s environment. As well, preferreds can offer qualified dividend income (QDI) tax advantages in the U.S.

EXHIBIT 1

Preferreds absolute and relative yields remain attractive

Yield to maturity, June 30, 2022

At June 30, 2022. Source: ICE BofA, Bloomberg.
Data quoted represents past performance, which is no guarantee of future results. The information presented above does not reflect the performance of any fund or account managed or serviced by Cohen & Steers, and there is no guarantee that investors will experience the type of performance reflected above. There is no guarantee that any historical trend illustrated above will be repeated in the future, and there is no way to predict precisely when such a trend might begin. Average calculations based on monthly observations.
(1) ICE BofA Fixed Rate Preferred Securities Index tracks the performance of fixed-rate U.S. dollar-denominated preferred securities issued in the U.S. domestic market. (2)ICE BofA Corporate Master Index (Credit quality: A-) tracks the performance of U.S. dollar-denominated investment-grade corporate debt publicly issued in the U.S. domestic market. (3) ICE BofA Municipal Master Index (Credit quality: AA-) tracks the performance of U.S. dollar-denominated investment-grade tax-exempt debt publicly issued by U.S. states and territories, and their political subdivisions, in the U.S. domestic market.(4) ICE BofA High-Yield Master Index (Credit quality: B+) tracks the performance of U.S. dollar-denominated below-investment-grade corporate debt publicly issued in the U.S. domestic market.

2. Preferreds can be an attractive alternative to high-yield bonds

Looking more closely at preferreds vs. high yield bonds, the yield differential has widened in recent months, as high yield has more aggressively priced in the risk of slowing growth/recession. High yield currently offers about 250 basis points of income over preferreds, compared with a long-term average of 209 basis points (Exhibit 2). However, the quality of preferreds is triple B on average (based on the domestic preferred market as of June 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 further slowdown caused by rising rates, and historically have tended to have significantly lower default rates than high yield during recessions/slowdowns.

EXHIBIT 2

Risk-adjusted yield spreads could indicate value for Long-term average spread (1997-2022): 209 bps preferreds

Yield comparison—high-yield bonds vs. preferred securities January 1997–June 30, 2022

At June 30, 2022. Source: ICE BofA.
Data quoted represents past performance, which is no guarantee of future results. The information presented above does not reflect the performance of any fund or other account managed or serviced by Cohen & Steers, and there is no guarantee that investors will experience the type of performance reflected above. There is no guarantee that any historical trend illustrated above will be repeated in the future or any way to know in advance when such a trend might begin.
Debt securities including preferred securities, corporate bonds, municipal bonds and high yield bonds generally present various risks, including interest rate risk, credit risk, call risk, prepayment and extension risk, convertible securities risk, and liquidity risk. The mention of specific securities is not a recommendation or solicitation for any person to buy, sell or hold any particular security and should not be relied upon as investment advice. Note: Yields shown on a yield-to-maturity basis.
(1) ICE BofA High-Yield Master Index tracks the performance of U.S. dollar-denominated below-investment-grade corporate debt publicly issued in the U.S. domestic market. (2) ICE BofA Fixed Rate Preferred Securities Index tracks the performance of fixed-rate U.S. dollar-denominated preferred securities issued in the U.S. domestic market. (3) Long-term average starts 1/31/1997 and ends 6/30/2022. Yield spread is the difference between yields on differing debt instruments, calculated by deducting the yield of one instrument from another. Yield spread is the difference between yields on differing debt instruments, calculated by deducting the yield of one instrument from another.

Yields on preferred securities appear attractive vs. high-yield bonds on a risk-adjusted 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.

EXHIBIT 3

Capital strength in U.S. and European banks near all-time highs

At March 31, 2022. Source: Bloomberg.
Data quoted represents past performance, which is no guarantee of future results. The information presented above does not reflect the performance of any fund or other account managed or serviced by Cohen & Steers, and there is no guarantee that investors will experience the type of performance reflected above. There is no guarantee that any historical trend illustrated above will be repeated in the future or any way to know in advance when such a trend might begin. The views and opinions are as of the date of publication and are subject to change without notice. The core capital ratio is the ratio of core (common equity) capital to total risk-weighted assets. Banks must meet a minimum core capital requirement as dictated by local banking laws and regulations. Higher core capital ratios have helped to strengthen banks’ balance sheets and to improve their credit quality. (1) Core Capital ratios based on the largest U.S. banks including Bank of America Corporation, JPMorgan Chase & Co., Citigroup Inc., Wells Fargo & Company, U.S. Bancorp, PNC Financial Services Group, Inc., SunTrust Banks, Inc., BB&T Corporation, Regions Financial Corporation, KeyCorp, M&T Bank Corporation, Comerica Incorporated, Synovus Financial Corp. and First Horizon National Corporation. The mention of specific securities is not a recommendation or solicitation for any person to buy, sell or hold any particular security and should not be relied upon as investment advice. (2) Core Capital ratios based on the following 15 major European banks: HSBC Holdings Plc, Deutsche Bank AG, BNP Paribas SA, Crédit Agricole SA, Barclays Plc, Société Générale SA, Banco Santander SA, NatWest Group plc, UBS AG, Credit Suisse Group AG, UniCredit SpA, Lloyds Banking Group Plc, Intesa Sanpaolo SpA, Commerzbank AG and Banco Bilbao Vizcaya Argentaria, SA. The mention of specific securities is not a recommendation or solicitation for any person to buy, sell or hold any particular security and should not be relied upon as investment advice.

Current positioning

In light of the prospect of tighter financial conditions and an increasingly uncertain macro backdrop, we have become more defensive in both our core preferreds and low-duration preferreds strategies. We have reduced some of our credit overweight while favoring higher-quality and higher-reset (spread over benchmark upon coupon reset) structures. Specifically, we have shortened portfolio rate and spread durations by increasing investments in shorter-duration preferreds that both 1) have coupon resets within 1 to 5 years; and 2) have high reset levels.