With interest rates headed still higher after sharp increases this year, now may be the time to consider preferred stocks. Some of these securities yield more than 6%.
Recall that preferred stocks are a hybrid between stocks and bonds. They pay regular dividends and preferred stockholders have a higher claim on those dividends than common shareholders.
Preferred stocks generally don’t fluctuate as much in value as common stocks, because the benefit of owning a preferred stock is its dividend payments rather than a capital gain.
Preferred stock issuers are generally high-quality financial companies, along with pipeline and utility operators.
“They currently offer a higher yield than most other bond-like investments and dividend-paying stocks,” notes Morningstar data journalist Katherine Lynch.
Outperformance vs. Stocks
The Bank of America Merrill Lynch Core Fixed Rate Preferred Securities Index slid 16% year to date through Oct. 14, compared to a 25% drop for the S&P 500. Some experts say the decline of preferred stocks makes them a good buy now.
To be sure, preferred stocks carry more risk than bonds. In 2020, several preferred stock issuers deferred or cancelled dividend payments, Lynch explained.
Preferred stocks are usually issued for 30 or more years, so they’re sensitive to interest rate changes, Lynch said. “To compensate for this risk, they carry high yields that can help buffer the negative impact of rising rates.” That has been the case this year.
Given the risks of preferred stocks, you might want to consider investing in preferred stock exchange traded funds (ETFs) or mutual funds, Morningstar points out. That way you get diversification.
The biggest preferred-stock ETF is iShares Preferred & Income Securities ETF PFF, with assets of $13.8 billion. The second biggest is First Trust Preferred Securities & Income ETF (FPE), with assets of $6 billion. And No.3 is Invesco Preferred ETF (PGX), with assets of $4.9 billion.
iShares Preferred & Income Securities has Morningstar’s highest rating of gold. “A sound investment process and strong management team underpin” that rating, according to an auto-generated Morningstar analysis.
“The portfolio maintains a sizable cost advantage over competitors, priced within the lowest fee quintile among peers.”
First Trust Preferred Securities & Income gets only a neutral rating from Morningstar, below its gold, silver and bronze classifications.
“Overall performance since the ETF's 2013 launch has been mixed on both a total-return and risk-adjusted basis,” Morningstar analyst Chiayi Tsui wrote in a commentary.
Invesco Preferred ETF also has a neutral Morningstar rating. Morningstar’s auto-generated analysis gives the fund average ratings for its process and parent categories. That’s what keeps the overall rating at neutral.
To be sure, “the portfolio maintains a cost advantage over competitors, priced within the lowest fee quintile among peers,” Morningstar said.
