With Interest Rates Poised To Decline, Preferred ETFs Can Shine

As markets price in expectations for one or two interest rate reductions by the Federal Reserve this year, income investors are poised to embrace high-yielding assets if the Fed makes good on lower rates. As it is, some high income assets, including preferred stocks, are already benefiting this year.

What Happened

The Global X SuperIncome Preferred ETF SPFF is up nearly 7% year to date, an admirable showing when accounting for SPFF's 30-day SEC yield of 5.9% and preferreds' tendency to usually be a slow-moving asset class.

The $192.38 million SPFF tracks the S&P Enhanced Yield North American Preferred Stock Index and can be described as the yield hunter's preferred ETF. That's saying something because essentially all of the ETFs in this space feature higher yields than 10-year Treasuries and investment-grade corporate bonds.

SPFF's “invests in 50 of the highest yielding preferred stocks in North America,” according to Global X. SPFF's 30-day SEC yield is nearly 65 basis points higher than that of the larges preferred ETF.

Why It's Important

While high yields are often seductive, spreads indicate SPFF is worth a look in the current environment.

“Preferreds, on the other hand, currently look more appealing as spreads are more in line with their historical averages,” according to Global X research. “While high yield debt has spreads that are 133 basis points lower than their long term average, and investment grade debt is 36 basis points lower, preferreds are virtually in-line with historical figures. This shows that they are more fairly priced based on historical data than traditional corporate debt that looks expensive.”

Preferreds' spreads relative to traditional junk bonds are meaningful because many preferreds themselves carry junk ratings. In the case of SPFF, about 70% of the fund's holdings carry ratings of BB- to BBB+, meaning only a scant percentage of the ETF's components are rated investment-grade.

What's Next

Remembering that many of today's preferreds were issued by banks during the global financial crisis as means of raising capital, the health of domestic banks is integral to the SPFF thesis. Fortunately, the health of those banks is mostly robust.

“A defining characteristic of preferreds is the prevalence of issuance by banks, because of the incentives to reduce leverage post-financial crisis and for regulatory reasons that include preferred stock being part of certain Tier 1 capital ratios,” said Global X. “Therefore, the health of the banking sector plays an important role in determining the riskiness of the preferred market.”

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Photo credit: Dan Smith - Own work via Wikimedia Commons