With many investors turning to riskier bonds for yield, diversification is key. Pairing high-yield bonds with preferreds, which have attractive yields and distinct characteristics, may complement traditional fixed income holdings.
KEY TAKEAWAYS
- Preferreds offer some of the highest income rates available from investment-grade fixed income, before and after taxes.
- With low overlap in issuers, preferreds can provide portfolio diversification when included with a high-yield allocation.
- Preferreds, which are trading at historically attractive valuations, have the potential to improve risk-adjusted returns.
Different sources of income
Preferred securities are issued mostly by companies with high credit ratings yet generally offer yields similar to bonds that are several notches lower in quality. With high yield, the extra income is driven by higher credit risk. Preferreds investors are paid extra for subordination (having a lower claim on company assets in the event of liquidation), the possibility that payments may be omitted or deferred (historically rare in practice), and the general complexity of preferred securities. While diversification does not protect against loss, preferreds’ characteristics help to diversify an investor’s exposure to various risks. Many preferred securities generate qualified dividend income (QDI), which is taxed at a lower rate than interest income— making preferreds’ after-tax yields competitive with high yield bonds
EXHIBIT 1
Preferreds offer attractive income with significantly less credit risk
Average credit ratings and yields
At December 31, 2024. Source: ICE, Standard & Poor’s, Cohen & Steers.
Past performance is no guarantee of future results. The information is for illustrative purposes only and does not reflect the performance of any fund or account managed by Cohen & Steers. Yields are shown on a yield-to-maturity basis. After-tax yields assume taxation at the highest marginal U.S. Federal income tax rates of 37% for taxable interest income and 20% for qualified dividend income (QDI), with an additional 3.8% Medicare surcharge on all tax rates. After-tax calculations assume preferred securities income is taxed at the respective qualified dividend rate and marginal tax rate on a 65/35 blended basis. Preferred securities are represented by the ICE Large Cap Capital Securities Custom Index (USD Hedged). High yield bonds are represented by the ICE BofA High Yield Bond Index. See endnotes for index definitions and additional disclosures.
Different sectors, different behaviors
Preferreds are typically offered by companies in highly regulated industries, such as financial services and utilities, and by hard-asset, high-cash-flow companies, such as pipelines and real estate investment trusts (REITs), with stability of cash flows providing historically low default rates. By contrast, the high yield market is more concentrated in economically sensitive sectors such as consumer cyclicals, industrials and basic materials, which has historically led to higher volatility. By combining preferreds with high yield, investors may be less vulnerable to stress in any one area of the market.
Preferreds have historically had greater diversifying correlations with equities and other fixed income investments. This is partly because companies that issue preferreds are generally less represented in traditional bond markets, including high yield. Also, preferred securities are structured differently than normal bonds, with most preferreds having duration-lowering resetting coupons, resulting in distinct characteristics. Low correlations indicate the potential of preferreds to serve as an effective portfolio diversifier.
EXHIBIT 2
Preferreds can be a source of diversification in fixed income portfolios
Overview of the $1.3 trillion preferred market
At December 31, 2024. Source: Bloomberg, ICE, Cohen & Steers.
Past performance is no guarantee of future results. The information above is for illustrative purposes only and does not reflect the performance of any fund or account managed by Cohen & Steers. Correlation is a statistical measure of how two data series move in relation to each other, with 1 indicating perfect synchronization and 0 indicating perfect randomness. See endnotes for index associations, definitions and additional disclosures.
Attractive relative value
The difference in income between high yield bonds and preferred securities is relatively small today compared to history. In addition, contingent capital securities (CoCos), which represent a growing portion of the global preferred securities market, currently offer higher income rates than high yield. We believe this represents an opportunity to allocate to preferred securities at attractive relative values.
EXHIBIT 3
Historically low yield spread indicates potential relative value
Yield comparison
High yield bonds vs. Preferred securities (January 2014–December 31, 2024)
At December 31, 2024. Source: ICE, Cohen & Steers.
Past performance is no guarantee of future results. 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. Yields are shown on a yield-to-maturity basis. Preferred securities are represented by the ICE Large Cap Capital Securities Custom Index (USD hedged). High yield bonds are represented by the ICE BofA High Yield Bond Index. Based on monthly observations. The yield spread is the difference between yields on differing debt instruments. See endnotes for definitions and additional disclosures.
Better together
A history of low correlations and strong returns suggests that an allocation to preferred securities may be an effective way to diversify high yield bonds. Over the past five years, a 50/50 mix of high yield and preferreds would have provided better returns than high yield bonds alone but with less volatility, resulting in better risk-adjusted performance and higher after-tax income.
EXHIBIT 4
A preferred allocation has historically improved risk-adjusted returns
Performance characteristics (five years ended December 31, 2024)
At December 31, 2024. Source: ICE, Cohen & Steers.
Past performance 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. Preferred securities are represented by the ICE Large Cap Capital Securities Custom Index (USD hedged). High yield bonds are represented by the ICE BofA High Yield Bond Index. Volatility is measured by standard deviation, which shows how much variation (or dispersion) exists from the average. Yields shown are on a yield-to-maturity basis. After-tax yields assume taxation at the highest marginal U.S. Federal income tax rates of 37% for taxable interest income and 20% for qualified dividend income (QDI), with an additional 3.8% Medicare surcharge on all tax rates. After-tax calculations assume preferred securities income is taxed at the respective qualified dividend rate and marginal tax rate on a 65/35 blended basis. See endnotes for index definitions and additional disclosures.
FURTHER READING
Tariffs, volatility and the opportunity in preferred securities
In a market shaped by tariffs and volatility, we explore how preferred securities are holding up—and where we see opportunity ahead.
3 Reasons to own preferred securities today
We believe an exceptional buying opportunity for preferred securities may exist today.
Capital Market Assumptions
Expected returns for the next 10 years amid elevated inflation and resilient global growth
Important definitions and important disclosures
An investor cannot invest directly in an index and index performance does not reflect the deduction of any fees, expenses or taxes. Index comparisons have limitations, as volatility and other characteristics may differ from a particular investment.
Preferred securities: ICE Large Cap Capital Securities Custom Index (USD Hedged), captures the largest and most liquid securities in the global preferred securities market setting a minimum deal size of $750mm and limits the number of high yield companies to large domestic champions or multinationals. Currency risk is hedged back to the USD. The Bloomberg U.S. Aggregate Bond Index is a broad-market measure of the U.S. dollar-denominated investment-grade fixed-rate taxable bond market. Corporate bonds: ICE BofA U.S. Corporate Bond Index, which tracks the performance of U.S. dollar-denominated investment-grade corporate debt publicly issued in the U.S. domestic market. High yield bonds: ICE BofA U.S. High Yield Bond Index, which tracks the performance of U.S. dollar-denominated below-investment-grade corporate debt publicly issued in the U.S. domestic market. Municipal bonds: ICE BofA Municipal Bond Index, which tracks the performance of U.S. dollar-denominated U.S. municipal tax-exempt investment grade bond market. U.S. equities: S&P 500 Index, which is an unmanaged index of 500 large-capitalization stocks that is frequently used as a general measure of U.S. stock market performance. U.S. Treasuries: ICE BofA U.S. Treasury Index, which tracks the performance of U.S. dollar-denominated sovereign debt publicly issued by the U.S. government in its domestic market.
Risks. There are special risks associated with investing in the Fund. All investments involve risks, including loss of capital, and there is no guarantee that investment objectives will be met. The Fund is subject to special risk considerations similar to those associated with the direct ownership of real estate due to its policy of concentration in the securities of real estate companies. Real estate valuations may be subject to factors such as changing general and local economic, financial, competitive and environmental conditions.
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. The strategies’ benchmarks do not contain below-investment-grade securities.
Contingent capital securities (CoCos). CoCos are debt or preferred securities with loss absorption characteristics built into the terms of the security, for example, a mandatory conversion into common stock of the issuer under certain circumstances, such as the issuer’s capital ratio falling below a certain level. Since the common stock of the issuer may not pay a dividend, investors in these instruments could experience a reduced income rate, potentially to zero, and conversion would deepen the subordination of the investor, hence worsening the investor’s standing in a bankruptcy. Some CoCos provide for a reduction in the value or principal amount of the security under such circumstances. In addition, most CoCos are considered to be high-yield securities and are therefore subject to the risks of investing in below-investment-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. The duration of a security will be expected to change over time with changes in market factors and time to maturity.
There is no guarantee that any market forecast set forth in this presentation will be realized. This material represents an assessment of the market environment at a specific point in time and 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 presentation 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. The views and opinions expressed are not necessarily those of any broker/dealer or its affiliates. Nothing discussed or suggested should be construed as permission to supersede or circumvent any broker/dealer policies, procedures, rules or guidelines.
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Publication Date: March 2025. Copyright © 2025 Cohen & Steers, Inc. All rights reserved.