Investors are often attracted to passive strategies due to lower expenses. But cheaper does not necessarily mean better. Market disparities and inefficiences, as well as poor benchmark construction in certain asset classes, can make active management the better option. In such markets, the potential for excess returns, relative to passive strategies, may more than make up for higher expense ratios. This is particularly true for preferred securities (and, to a lesser degree, for fixed income investments in general).

Exhibit 1 shows that on a three-year basis, 92% of active preferred stock funds outperformed the typical passive preferred fund, and, on average, generated a return more than two percentage points greater than their passive counterparts. Active managers achieved similarly compelling performance over five- and 10-year periods.

Success rate and average excess return vs. passive funds

At December 31, 2024. Source: Morningstar Direct, Cohen & Steers.
The information presented is for illustrative purposes only. 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. Returns are net of fees. (a) Success rate is defined as the percentage of funds within a specific Morningstar category that both survived the sample period in question and delivered returns exceeding the equal-weighted average return of passive funds in the same category over that period. For mutual funds, institutional share class returns were used. (b) These portfolios tend to have more credit risk than government or agency-backed bonds, and effective duration (a measure of interest rate sensitivity) longer than other bond portfolios. These portfolios hold more than 65% of assets in preferred stocks and perpetual bonds. (c) Portfolios concentrate on investment-grade bonds issued by corporations in U.S. dollars, which tend to have more credit risk than government or agency-backed bonds. These portfolios hold more than 65% of their assets in corporate debt, less than 40% of their assets in non-U.S. debt and less than 35% in below-investment-grade debt, and they have durations that typically range between 75% and 150% of the three-year average of the effective duration of the Morningstar Core Bond Index. (d) Concentrate on lower-quality bonds, which are riskier than those of higher-quality companies. These portfolios generally offer higher yields than other types of portfolios, but they are also more vulnerable to economic and credit risk. These portfolios primarily invest in U.S. high-income debt securities, where at least 65% of bond assets are not rated or are rated by a major agency at the level of BB (considered speculative for taxable bonds) and below. (e) Invest primarily in investment-grade U.S. fixed income issues, including government, corporate, and securitized debt, and hold less than 5% in below-investment-grade exposures. Their durations typically range between 75% and 125% of the three-year average of the effective duration of the Morningstar Core Bond Index. See endnotes for additional disclosures.

The global preferred securities market offers a diverse range of market structures, geographic access and duration profiles (Exhibit 2). And active managers can add value in a variety of ways that are typically unavailable to passive strategies. These include:

Access and diversification: Of the $1.3 trillion preferred securities market, nearly $900 billion is composed of securities issued by foreign institutions. Passive strategies often focus on narrow segments, such as $25 par exchange- traded preferreds—a small and shrinking portion of the market. Active managers can typically cast a wider net, accessing both U.S. exchange-traded securities and the global, institutional over-the-counter (OTC) market, a broader universe of liquid securities across geographies, sectors and currencies.

Risk management: Fixed-rate securities, which have longer durations and greater interest rate sensitivity, dominate the $25 par market. In contrast, the OTC market offers both short- and long-duration profiles across multiple currencies, giving active strategies greater ability to manage duration and interest rate risk. In addition, as different countries have distinct monetary policy paths, investing in non-USD securities can provide another tool to manage interest rate risk. Credit risk is also a key consideration. Passive strategies are tied to an index, where issuers with larger volumes of securities typically receive higher weights.

Alpha generation prospects: Differences across preferred markets create opportunities for active managers to generate excess returns. Many preferred issuers offer securities in multiple markets and currencies. There is potential for active managers to take advantage of material differences in securities structures, prices and/or yields. Investors can often find better relative value for securities of the same issuer in one market than in another. We believe active managers with the skill and resources to access the full universe of preferred securities better serve investors. Not only can this offer a broader opportunity set for finding value, but it can also enhance the ability to manage through economic and interest rate cycles.

Overview of the $1.3 trillion preferred market

At December 31, 2024. Source: Bloomberg, Cohen & Steers.
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. Based on par values of approximately 1,702 capital securities and other deferrable debt instruments denominated in USD, EUR and GBP and issued in the major domestic and Eurobond markets. Generally, denomination size must be a minimum of US$100 million if issued in the U.S. retail market, US$150 million if issued in the U.S. institutional market, EUR 200 million, or GBP 200 million to qualify for inclusion in our universe. Mandatory convertible preferred securities are excluded. Additionally, exchange-traded senior debt securities are included. Other issuers include the Cayman Islands, Puerto Rico, Qatar, Russia, South Africa, Togo, United Arab Emirates, Israel and supranational institutions. Percentages may not sum due to rounding. See endnotes for additional disclosures.

Sign up to get our insights delivered to your inbox

Subscribe

Preferred securities can be sensitive to the effects of changes in interest rates and evolving economic conditions. Active investment managers have an assortment of tools at their disposal to effectively manage through those changing conditions.

A preferred security’s structure can significantly affect its duration (Exhibit 3). Generally, the higher the duration, the greater the price change in response to a rise or fall in rates. Selecting the right structure can be a powerful defense against interest rate risk in a rising-rate environment. Active managers not limited to the U.S. exchange-traded market (which is dominated by fixed-rate securities) can acquire preferreds with rate-resetting structures. Floating-rate preferreds help mitigate interest rate risk, as their coupons adjust with short-term rates, increasing as rates rise. Similarly, fixed-to-fixed and fixed-to- floating-rate preferreds initially pay a fixed rate but later reset to a new fixed rate or a floating rate, reducing interest rate risk over time.

Below are a few other tools active managers may consider depending on prevailing interest rates and economic conditions.

• Set allocations to securities based on credit quality and credit spreads
• Employ securities with different structures and reset spreads
• Exercise discretion on higher/lower-coupon securities across retail and institutional markets
• Diversify across other interest rate regimes by investing in foreign currency–denominated securities
• Use derivatives to hedge interest rate and credit risk directly

Generally, the higher the duration, the greater the price change in response to a rise or fall in rates.

Hypothetical examples

At December 31, 2024. Source: Cohen & Steers.
This chart is for illustrative purposes only and does not reflect information about any fund or other account managed or serviced by Cohen & Steers. Duration measures the price sensitivity of a fixed income or preferred security to changes in interest rates (or yields). The higher the duration, the greater the price change in response to a rise or fall in yield. The duration of a preferred security depends, in part, on how it is structured. Fixed-rate security duration assumes the security trades at a discount to par. The duration of a floating-rate preferred security will be highly dependent on the reference rate (the rate that the floating rate security floats off of) being benchmarked to and if that reference rate is the rate that is moving. (a) SOFR: Secured Overnight Financing Rate. See endnotes for additional disclosures.

The diversification of the preferred market by security type, rate structure, credit risk, geography and currency, to name a few factors, means that performance can vary widely by market segment (Exhibit 4). This return dispersion represents another avenue, typically unavailable to passive strategies, for active managers to generate excess returns.

Annual returns ranked from best to worst (%)

At December 31, 2024. Source: ICE BofA, Cohen & Steers.
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. Returns are hedged to the U.S. dollar. See endnotes for index definitions and additional disclosures.