Wall Street: "No Need to Burn Money on Junk Bonds"...Recommends 6 Preferred Stock ETFs with Lower Credit Risk

▲ Junk bonds, preferred stock ETFs/AI-generated image

Wall Street's assessment is that there's no reason to take on greater credit risk even if junk bonds offer a 7.45% yield. As the yield on investment-grade preferred stocks rose to 6.5%, narrowing the gap with junk bonds to less than 1 percentage point, Barron's suggested six preferred stock ETFs as alternatives.

According to Barron's, a U.S. investment media outlet, on July 8 (local time), preferred stocks, which combine characteristics of both stocks and bonds, are emerging as an investment alternative in the expensive bond market. As of July 1, the yield on the ICE BofA US Preferred & Hybrid Securities Index was 6.5%. This is higher than investment-grade corporate bonds (5.25%) and the gap with junk bonds (7.45%) is only 0.95 percentage points.

Brian Cordes, head of the portfolio specialist group at Cohen & Steers, explained that junk bonds typically offer a 2.19 percentage point higher yield than preferred stocks. The current gap has narrowed to about 1 percentage point. Cordes stated, "You can find relatively much better value in preferred stocks," adding, "There's no need to lower your credit level for yield."

Taxes were also cited as a strength of preferred stocks. A significant portion of preferred stock dividends are classified as qualified dividend income, subject to a maximum tax rate of 20%. This is a significant difference from ordinary income, which can be subject to up to 37% in the highest tax bracket. Doug Baker, portfolio manager for Nuveen's global fixed income team, assessed that the financial conditions of major preferred stock issuers such as banks, insurance companies, and utility companies are robust. New preferred stock issuance by U.S. banks is expected to be $12-13 billion over the next 18 months.

Barron's named the $13 billion iShares Preferred & Income Securities ETF (PFF), the $3.9 billion Invesco Preferred ETF (PGX), and the $2.2 billion Global X U.S. Preferred ETF (PFFD) as representative products. For products that reduce interest rate fluctuation risk, it suggested the $3 billion Invesco Variable Rate Preferred (VRP), the $6.4 billion First Trust Preferred Securities & Income (FPE), and the $100 million Goldman Sachs Access U.S. Preferred Stock & Hybrid Securities (GPRF).

However, preferred stock ETFs can also be vulnerable to rising interest rates and market volatility. Some products are sensitive to interest rate changes, meaning their prices could fall if the Federal Reserve raises rates, and the bid-ask spread could widen significantly if market instability increases. David Krakauer, Vice President of Portfolio Management at Mercer Advisors, stated that "it can be somewhat tricky to trade at a good price" and that a significant portion of expected returns could be forfeited due to widened spreads.

[Article Summary]

-The yield on the investment-grade preferred stock index is 6.5%, narrowing the gap with junk bonds (7.45%) to 0.95 percentage points.

-Barron's suggested six preferred stock ETFs, including PFF, PGX, PFFD, VRP, FPE, and GPRF, as investment alternatives in the bond market.

-Preferred stocks have strengths in terms of taxes and credit quality, but carry risks of price decline and widening bid-ask spreads during interest rate hikes and market volatility.

*Disclaimer: This article is for investment reference only, and we are not responsible for any investment losses based on it. The content should be interpreted for informational purposes only.*