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CIP Quips

Picking Up Yield with Preferreds

What's in the news: 

Over the past few months the U.S. Treasury 10 year yield has risen slightly over 100 basis points from it’s July trough [1].  Still too low in our opinion for income oriented investors. In a recent Wall Street Journal Article, Jeff Brown posed the following question, “What if you could earn 6% or 7% in a security that is safer than a junk bond and is issued by a sound U.S. company?”  

Referring to the ranges that preferred securities dividends pay, Mr. Brown touched on the fact that many preferreds pay dividends near that 6-7% range:

So why aren’t preferreds used more frequently? Because advisors often tend to shy away from owning individual preferred securities due to the tedious work needed to follow call provisions, credit ratings and tax treatment, but alas some advisors will look to buy the overall space via an Exchange Traded Funds, which can be a simple way to diversify investor accounts at different fee levels.  

There are other manners investors can realize a  6-7% yield, for example as of 12/31/16 the Barclays Capital U.S. Corporate High Yield Index offered a 6.51% yield. But is it really worth the risk to diversify a portfolio using junk bonds when you could be incorporating less risky instruments with a similar result?

We don’t think so.

Source: Bloomberg

What are we thinking?

A primary purpose of an allocation to preferred stock and a significant (about 30%) allocation to short-term bonds rather than “reaching for yield” is to preserve CIP portfolios flexibility if and when interest rates rise significantly. When the two are paired together, we believe CIP portfolios are well-positioned to produce current income in excess of alternative income vehicles while retaining the equally important ability to increase these income levels when the opportunities arise. 

While we think highly of preferreds, we know one of the biggest challenges they face is in a rising interest rate environment, which can cause price depreciation. We believe that as we return to a normalized rate environment we can expect the value of holding preferred securities to diminish. CIP can go from 40% to 15% in investment grade preferred stock, taking advantage of both a low rate environment and a rising rate environment with our strategic diversification and hands-on portfolio management. 



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