Is now the time for preferred stocks?
Sometimes I’m asked if preferred stocks will remain an attractive asset class in a rising rate environment. While it is true that preferred stocks may see price declines as traditional long-term bonds would, the losses may be more than offset by the potential yield. Additionally, because we expect the rate rises to be gradual, we wouldn’t expect to see big downward spikes in preferred prices. Preferred stocks may also be attractive due to the fact that they’re issued mainly by financial companies, like banks. That’s because banks have historically tended to do well in rising rate environments, as they can benefit from making loans at higher interest rates.
If you’re looking for another source of income in your portfolio, you may want to consider preferred stocks.
Market Realist – Banks make up a big chunk of the iShares US Preferred Shares ETF.
As we mentioned earlier in this series, rising interest rates may not affect preferred shares as much as one might think. The graph above shows the sector weights for the iShares US Preferred Shares ETF (PFF). Banks (KRE) make up as much as 40.4% of the ETF. Financials (IYF)(RWW) as a whole make up ~68% of the fund.
Now, financials tend to do well when interest rates rise. Rates usually rise when the economy is improving. Given the cyclical nature of financials, rising interest rates would actually benefit them, especially banks, as explained above.
Banks’ profitability has been hurt since the great recession, as interest rates remained at record lows. However, as the Fed gets ready to raise rates for the first time in ten years, banks may see increased profitability, which would positively affect preferred stocks.
If you want global diversification, the iShares S&P International Preferred Stock Index (IPFF) gives you exposure to international preferred stocks.
Read Why investors should be careful investing in preferred stock ETFs for more about preferred stocks.