Upcoming call dates/dividend resets provide preferred securities with a potential catalyst in today’s uncertain market. Primarily issued by investment-grade-rated companies, preferred yields are currently in the 7–9% range. Most preferreds come with dividend-resetting structures, potentially leading to income growth for investors in the face of sustained interest rates. Additionally, many securities are selling at 10–20% discounts to par value. Given their historical trend of trading near par, these deep discounts present significant potential for capital appreciation for patient investors.
Transcript
Hi, I’m Brian Cordes, Head of the Portfolio Specialist Group at Cohen & Steers.
We believe preferred securities present a compelling total return opportunity in today’s market.
High-quality preferreds, primarily issued by investment-grade-rated companies, offer 7 to 9% yields, as of mid-November, 2023, which is considerably greater than what’s available from investment-grade corporate bonds.
Many preferreds are also selling at 10 to 20% discounts to par value. Historically, these securities trade near par, so the deep discounts represent significant capital appreciation potential for patient investors.
And there’s a sometimes overlooked aspect to preferreds, unavailable from most other fixed income categories, that makes them particularly compelling in today’s potentially “higher for longer” rate environment: their resetting dividends.
Over-the-counter preferreds, which represent roughly 80% of the preferreds universe, feature dividend reset structures, in contrast to exchange-traded preferred issues, which are primarily fixed rate in perpetuity.
More than 10% of the preferreds market will either reset or be called in the next 12 months. These securities typically were issued when short-term rates were significantly lower than they are today.
Given recent strength in the U.S. economy, Federal Reserve rate cuts are generally not anticipated before the second half of 2024. With preferreds’ periodic payment resets, just the passage of time (if we experience “higher for longer” rates) should lead to significant increases in income for investors if the securities are not called.
Here are a few real-life examples.
Most preferreds reset spreads are in the range of 250 to 400 basis points above a given benchmark.
Many reset over short rates, such as the secured overnight financing rate, or SOFR.
Others reset over longer benchmarks, such as 5-year U.S. Treasuries.
Typically, the nearer-dated fixed-to-reset securities are trading at more shallow discounts. In our view, this makes shorter-reset issues particularly attractive “paid-to-wait inflation-beaters” in the near term.
Of course, issuers have the right to redeem securities at par value at the reset date rather than increase the dividend. But with many shorter-reset securities currently trading at discounts to par, a redemption would only increase these securities’ total returns. And if a security is called, investors can then use the proceeds to invest in other issues that are most likely yielding more.
Income investors may be tempted to consider alternatives such as high-yield bonds and leveraged loans (also known as floating-rate loans). Both of these categories have been strong performers of late, in part because they, too, can offer lower interest rate sensitivity. Floating-rate instruments have benefited investors in a rising-rate environment.
But while high-yield bonds and leveraged loans offer greater pre-tax yields than preferreds, they are (as a market) substantially lower-quality investments. For instance, the high-yield market has a B+ average rating, described as “highly speculative” by the rating agencies. In contrast, preferreds are typically issued by investment-grade companies, and on average, possess a rating that is four to five notches higher than the high-yield market.
High-quality issues with resetting dividends are only part of the preferreds total return story, but they can offer comfort in an unsettled investment climate.
Thanks for watching.
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Preferred securities offer high current income potential with tax advantages
Preferreds’ income rates compare favorably with other fixed income classes on both a pre- and post-tax basis.
Data quoted represents past performance, which is no guarantee of future results. The information presented 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. There is no guarantee that any market forecast set forth in this video will be realized. There is no guarantee that any historical trend referenced herein will be repeated in the future, and there is no way to predict precisely when such a trend will begin. The mention of specific securities is not a recommendation or solicitation to buy, sell or hold any particular security and should not be relied upon as investment advice.
This video is for informational purposes and reflects prevailing conditions and our judgment as of November 30, 2023, which are subject to change. This material should not be relied upon as investment advice, does not constitute a recommendation to buy or sell a security or other investment and is not intended to predict or depict performance of any investment. This material is not being provided in a fiduciary capacity and is not intended to recommend any investment policy or investment strategy or take into account the specific objectives or circumstances of any investor. We consider the information in this video to be accurate, but we do not represent that it is complete or should be relied upon as the sole source of appropriateness for investment. Please consult with your investment, tax or legal professional regarding your individual circumstances prior to investing.
Risks of Investing in Preferred Securities. An investment in a preferred strategy is subject to investment risk, including the possible loss of the entire principal amount that you invest. The value of these securities, like other investments, may move up or down, sometimes rapidly and unpredictably. Our preferred strategies may invest in below-investment-grade securities and unrated securities judged to be below investment grade by the advisor. Below-investment-grade securities or equivalent unrated securities generally involve greater volatility of price and risk of loss of income and principal, and may be more susceptible to real or perceived adverse economic and competitive industry conditions than higher-grade securities.
Duration risk. Duration is a mathematical calculation of the average life of a fixed-income or preferred security that serves as a measure of the security's price risk to changes in interest rates (or yields). Securities with longer durations tend to be more sensitive to interest rate (or yield) changes than securities with shorter durations. Duration differs from maturity in that it considers potential changes to interest rates, and a security's coupon payments, yield, price and par value and call features, in addition to the amount of time until the security matures. Various techniques may be used to shorten or lengthen a portfolio's duration. The duration of a security will be expected to change over time with changes in market factors and time to maturity.