Tahoe Market Pulse: Be wary of several market ‘mirages’
August 3, 2016
In my October 1, 2015 column, "Are Preferreds Too Often Overlooked?", I wrote about the Renaissance Re Preferred 'C' saying that downside risk was very small.
It traded at par value ($25) and would one day be called at par. It's not at its par anymore. Because of price appreciation most preferreds, like this one, are well above par.
Trading above par puts investors at risk of having the security being called, always at par. That recently happened to investors holding a Barclay's preferred. The 'C' issue traded near $26 the day the announcement came that it would be called at $25. That was a bad day for 'C' shareholders.
New preferreds can't be called for five years. They, too, are trading well above par. For example, the J.P. Morgan Chase Preferred 'G' trades at $27.20 and can't be called until 2020.
It yields 5.6 percent, but that's not the return investors can expect. That's because sometime after 2020 it might be called at par, falling 8 percent. So today's investors are giving up a year's worth of dividends once the security is called.
Instead of examining current yield, a better measure of expected return is its yield-to-call. That worst-case computation calculates the annual rate of return if a preferred or bond is redeemed on its next call date. You can cut the J.P. Morgan's current yield by a third when you look at its yield-to-call.
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When it comes to preferred stock investing, I invest in individual issues. That's because I can limit holdings to those than can't be called for some time, or they have an attractive yield-to-call.
Exchange-traded funds, however, hold many preferreds and some of the holdings are far above par. The largest preferred ETF holds Wells Fargo Preferred 'J.' This preferred trades at $28.24 and is callable in 1-½ years. It currently yields 7 percent but could fall 11.5 percent as the end of 2017 approaches. Its yield-to-call is near zero, which is in line with 18-month debt instruments.
At the start of the year I listed preferred stocks as my favorite asset class for 2016. That was a good call. But it's getting harder to find attractive issues as investors realize interest rates will remain lower for longer.
Our warning: Watch out for prices far above their par value unless they have many years of call protection. They are not quite what they seem.
David Vomund is an Incline Village-based fee-only money manager. Information is found at http://www.VomundInvestments.com or by calling 775-832-8555. Clients hold the positions mentioned in this article. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.
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