Alternative Income through Preferred Securities

In an ever-changing interest rate environment, keeping tabs on the numerous corners of the yield market can be difficult. To help investors stay informed, we offer monthly commentary on income investing, covering the latest news, trends and investment opportunities. 

Entering into 2020, yields for many income producing securities were already low, as the second half of 2019 saw the first U.S. rate cuts in years to combat rising trade tension and slowing global growth. For many investors this reignited their search for yield. Now heading into 2021, that search continues as yields for most income producing assets ended 2020 even lower than where they stood one year ago. While additional stimulus payments and the vaccine rollout may help speed up the economic recovery, any substantial rate increases are unlikely in the near term and yield-starved investors will remain on the hunt for alternative income sources outside of traditional options.

Preferred securities are one alternative source of income that investors may want to consider when looking to enhance yield in their portfolios. Preferreds are considered hybrid securities, as they exhibit characteristics of both stocks and bonds, and can offer yield potential higher than that of a company’s common equity and senior debt. In addition to yield potential, preferred securities can also act as a useful diversifier in portfolios, especially during volatile periods, as they generally feature low correlations with equities and traditional fixed income instruments. The yield potential and diversification benefits of preferred securities has attracted investor attention of late. However, those interested in the space should be aware that a large majority of preferred securities are issued by banks and insurance companies, leading to an overconcentration of financials in the broad preferreds market.

To alleviate concerns of concentration risk, we believe investors should consider non-financial preferreds (“ex financials”), which provide a differentiated exposure to the space, resulting in greater sector diversification without sacrificing yield. In fact, ex financial preferreds have actually offered a yield pickup over the broad preferred market historically, and currently even out yield high-yield credit markets, despite about a third of the ex financials preferred market carrying an investment grade credit rating. Beyond sector diversification and a yield premium, ex financial preferreds also display a couple other notable features relative to financial preferreds or the broad-based universe. Excluding financial issuers also increases the proportion of preferreds paying cumulative distributions and lowers the proportion featuring near-term call dates relative to the broad preferreds market. These are important characteristics in today’s environment, where there are concerns of delayed or suspended payments and high incentive for issuers to call and reissue securities at lower rates.

The VanEck Vectors^® Preferred Securities ex Financials ETF (PFXF) provides thoughtful exposure to the preferreds market by excluding traditional financial companies. This results in greater sector diversification without sacrificing yield, as well as lower call and payment risk relative to the broad preferreds market. The Fund’s 30-day SEC yield was 5.31%, as of December 31, and we view this strategy as a compelling option for investors searching for an alternative income source to enhance yield and diversification in their portfolio.