Tahoe Market Pulse: Investors ‘prefer’ preferreds
May 25, 2016
In our 2015 year-end article "Outlook so-so for stocks, good for preferreds," we gave the bullish case for "preferred securities."
I followed that up by writing, "Investment grade preferreds are the best risk-to-reward opportunity as we head into 2016." So far, that's been spot-on.
A preferred is a "hybrid" security with characteristics of both a bond and a common stock. In the corporate structure and in liquidation it is junior to bonds and other debt, but senior to the common.
It is equity, just like common stock, which is why holders are junior to creditors. Preferreds pay quarterly dividends (not interest) at a fixed rate, though there are a few issues whose payments adjust in line with LIBOR. Most currently yield between 5 and 7 percent.
These outside-the-box securities are often overlooked because they are not liquid enough for large institutional investors. Plus, brokers don't follow them since people "invest" in preferreds rather than trade them. This is all to our advantage.
How good have they been? The largest preferred exchange-traded fund, U.S. Preferred Stock ETF (PFF), is up about 3.5 percent this year including dividends. I prefer to avoid its 0.47 percent expense and hold individual securities instead.
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Here's an update of the ones listed in my year-end article: Renaissance Re Preferred 'C' yields 5.9 percent.
It's up a few pennies this year so it's benefit is almost exclusively in the form of dividend payments. This security is callable so don't pay more than $25.40.
Another re-insurer is Partner Re. After being acquired, its Preferred 'D' became a 'G' issue. Investors received a one-time bonus payment that was the equivalent of receiving 1 percent annually for five years.
The new security yields 6.1 percent and is not callable for five years. The Partner Re and Renaissance Re preferreds pay qualified dividends, which at taxed at 15 percent for most people. That's a plus.
Finally, I recommended a REIT preferred, the Saul Centers Preferred 'C.' It yields 6.5 percent (not qualified). It has rallied too far so I'm only a buyer on weakness from here. Limit buys to $26.25 or lower. It doesn't trade a lot so use a limit order.
From a risk-reward standpoint, preferreds like these are very attractive and play an important role in most of my clients' portfolios.
Receiving 6 percent from dividends in securities that don't move much is very attractive in a sideways stock market and with low bond yields. When it comes to investing, boring can be good.
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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