Preferred Stock as Portfolio Ballast

Advice to the Advisors

Preferred Stock as Portfolio Ballast | Sheaff Brock Institutional

Preferred Stock as Portfolio Ballast

“Corporate bonds and preferred stocks are two of the most common ways for a company to raise capital,” Ravi Srikant writes in Investopedia, and income-seeking investors, he says, can make good use of both. While bonds make regular interest payments, preferreds pay fixed dividends, Srikant explains, going on to note three qualities the two investment types share:

  1. Interest rate sensitivity—the security’s price falls when interest rates rise.
  2. Callability—the issuer has the right to call back the security and issue fresh securities at a lower rate.
  3. Convertibility—the securities may be converted into a fixed number of shares of the common stock of the company.

As manager of the Sheaff Brock Preferred Income Portfolio Strategy, JR Humphreys sees the primary function of preferreds as providing income and as a portfolio diversifying factor.

In terms of interest rate sensitivity (the first similarity to bonds listed above), Humphreys points out, the past three years demonstrate that price change is just one part of the total return equation, with dividends and interest payments making up the rest. Over the past three years the Fed has been gradually tightening, yet the S&P Preferred Stock Total Return Index is up 12.10% (non-annualized 12/15/15 to 11/23/18) over that same period of time! Preferred stocks, although qualifying as fixed income, have benefitted from an improving economy, he explains.

Today’s investors need to be more than patient—they need to be innovative, and for no type of investor profile is that a truer statement than for seekers of portfolio income, observes Sheaff Brock Director and National Sales Manager Jim Murphy. An allocation to preferred stock may help meet today’s market challenges for those income seekers, serving to enhance income while at the same time serving as a portfolio diversifier.

However, when it comes to creating a workable, long-term investment portfolio, Humphreys points to certain complexities in the preferred securities market that can have the power to make a big difference in investor return in both the short and long run:

  1. $25 par preferreds trade like stocks (with a bid and an ask price on an exchange), while $1,000 par institutional preferreds trade more like bonds based on a spread. Information beyond coupon and current yield can be difficult for the average investor to access.
  2. Large Exchange-Traded-Funds include mostly $25 par preferred securities, with many trading at a negative yield-to-call. (For this reason, the Sheaff-Brock portfolios include institutional preferreds with a greater potential for positive yields-to-call.)
  3. There are quite a number of special categories of preferred stock which can enhance both risk reduction and portfolio income generation. These include cumulative preferred, callable preferred, adjustable-rate preferred, fixed-to-float preferred, and trust preferred.
  4. The Sheaff Brock portfolios include floating-rate preferred stock, (whose dividend is periodically reset according to a predetermined formula) and “floored floaters” (the coupon rate “floats” with the LIBOR index).

Investing in preferreds is both an art and a science, JR Humphreys concludes. In individual managed accounts (SMAs), including different types of preferred stock can provide portfolio ballast!

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