Tahoe Market Pulse: Not much selling in preferreds
November 9, 2016
High-yielding stocks have given ground and utilities, although still strong (plus 11% ytd), are off their highs. Does this mean investors are expecting much higher interest rates? No. Here's why: Preferred stocks, our favorite asset class for 2016, are near their highs. If investors were truly concerned about rising rates preferreds would be falling.
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? For several years they have returned more than the S&P 500 with a lot less volatility. I expect this trend to continue.
Because they have performed so well, there aren't many bargains. Most are far above their par value. There are some opportunities, however. I've often written about Renaissance Re Preferred 'C.' Previously it was just under par and I labeled it the best risk-to-reward security. Now it is above par and can be called at any time. Still, it yields 5.9 percent and pays a qualified dividend. It is attractive below $25.30.
ING Group 6.2% Preferred (ISP) is trading above its $25 par value and at risk of being called, but I'm comfortable buying the security below $25.50. At that price, it yields 6.1% and pays a qualified dividend.
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Finally, Saul Centers Preferred 'C' doesn't trade much, but patient investors can buy shares for under $26. It yields 6.6 percent (not qualified). It will go ex dividend at the start of the new year so volume will pick up at that time.
From a risk-reward standpoint, preferreds remain attractive. When stock returns are minimal, receiving six percent in a non-volatile security is attractive. That's especially true when money-market funds yield next to nothing.
Don't let Fed rate hikes scare you. Interest rates will remain low for years. I'll explain why on future columns.
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 advisor before purchasing any security.