Author Topic: Preferred Stock Investments  (Read 4536 times)

tooqk4u22

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Preferred Stock Investments
« on: August 20, 2013, 06:38:42 AM »
Preferreds like other fixed income classes have gotten beaten up with the rising rate scenario, but now yields look pretty good at over 6% whether it be individual high quality issues or ETF such as PFF or PGF. I have always been a fan of preferreds and IMO are now repricing to pretty reasonable levels and could be a nice add to your portfolio to smooth cash flow. 

Anybody else looking at preferreds.

fiveoclockshadow

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Re: Preferred Stock Investments
« Reply #1 on: August 20, 2013, 07:06:14 AM »
Preferred shares are a poor investment choice for individual investors.  They exist primarily for the tax advantaged treatment they offer to corporations, so a corporation might see benefit in investing in preferred shares.  Individual investors get no advantage and the market for preferred shares in the individual sector is composed of people "chasing yield" who don't understand they are a poor investment choice.

This is a good online article on why you should avoid preferred shares:

http://www.cbsnews.com/8301-505123_162-57413922/why-you-should-avoid-preferred-stocks/

Bottom line you will get a better return for lower risk by using other asset classes.

tooqk4u22

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Re: Preferred Stock Investments
« Reply #2 on: August 20, 2013, 08:06:16 AM »
Preferred shares are a poor investment choice for individual investors.  They exist primarily for the tax advantaged treatment they offer to corporations, so a corporation might see benefit in investing in preferred shares.  Individual investors get no advantage and the market for preferred shares in the individual sector is composed of people "chasing yield" who don't understand they are a poor investment choice.

This is a good online article on why you should avoid preferred shares:

http://www.cbsnews.com/8301-505123_162-57413922/why-you-should-avoid-preferred-stocks/

Bottom line you will get a better return for lower risk by using other asset classes.

I wouldn't call that a good article, I would call it a long article with a poor/biased view of preferreds but with some good information included.  The chasing yield comment you make is certainly true over the last year or two because of fed manipulation of markets but that is not historically the case.

Preferreds are also good for tax treatment for individual investors as well as most, not all, are taxed at the dividend rate and not ordinary income rate like bonds.   

fiveoclockshadow

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Re: Preferred Stock Investments
« Reply #3 on: August 20, 2013, 10:21:47 AM »
I wouldn't call that a good article, I would call it a long article with a poor/biased view of preferreds but with some good information included. 

Biased?  What is your basis for that claim?  He's written an entire book on alternate asset classes, he certainly doesn't have a bias against them in general but rather has good reason for rejecting preferred stock.  And he isn't alone.

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Preferreds are also good for tax treatment for individual investors as well as most, not all, are taxed at the dividend rate and not ordinary income rate like bonds.   

Better tax treatment than high yield bonds isn't exactly a ringing endorsement for an asset class.  The corporate buyers still get better tax treatment than an individual.  So buying preferred is sort of like buying a muni in a tax sheltered account - you get a lower return without the tax benefit.

Preferred equities are still equities despite their appearance as "fixed income".  If you need better long term return equities serve you better.  If you need fixed income bonds are better.  If you want something in between a mixture of bond and equity asset classes gives better risk/return than preferred.  Preferred combine the worst aspects of equities and bonds with no benefits.

brewer12345

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Re: Preferred Stock Investments
« Reply #4 on: August 20, 2013, 10:37:44 AM »
I look at preferreds as long dated junk.  Like junk, there are periods of time when buying them is a no-brainer.  Like junk, there are periods where you really don't want to own them.  I don't find either market attractive at the moment, but YMMV.  The thing I really don't like about preferreds is that when they default the losses are usually severe and they can be hard to estimate.  Junk bonds, OTOH, are usually not that hard to cuff for downside case risk if you do your credit work and look at the indentures.

fiveoclockshadow

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Re: Preferred Stock Investments
« Reply #5 on: August 20, 2013, 12:52:41 PM »
I look at preferreds as long dated junk. 

I think that is a really good perspective.

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Like junk, there are periods of time when buying them is a no-brainer. 

Fair point, and more refined than my blanket statement.  It assumes an inefficient market, which is rather rare, but it has occurred in the recent past.  When the risk premium is out of whack to your favor on any asset class it is probably a buy opportunity even if normally the asset class isn't worth considering.  Back to the OP's question, this means now is not a good time for junk or preferred.  Just after the crash was when the risk premium was out of whack, now it is not.

KingCoin

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Re: Preferred Stock Investments
« Reply #6 on: August 20, 2013, 01:13:50 PM »
Yeah, I think there are much better opportunities out there if you're looking to take a contrarian view on rates, especially if you only have a 6% yield bogey.

grandcanyon

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Re: Preferred Stock Investments
« Reply #7 on: August 20, 2013, 03:56:35 PM »
Yeah, I think there are much better opportunities out there if you're looking to take a contrarian view on rates, especially if you only have a 6% yield bogey.
Any suggestions on this as I only need 6%?

I was in PFF and it wasn't a pleasant ride. I think it has further to fall IMHO. I wouldn't want to be in it with rates rising, QE stopping, and the economy improving.

KingCoin

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Re: Preferred Stock Investments
« Reply #8 on: August 21, 2013, 10:49:52 AM »

Any suggestions on this as I only need 6%?

I wouldn't want to be in it with rates rising, QE stopping, and the economy improving.

Almost no fixed income investments will suit this view (except perhaps very distressed or very short dated securities).

If youíre looking for something low risk in the 6% area, I like securities like ticker ELB which is first lien mortgage paper on Entergy. If you purchase @ $24, youíre looking at a 6.3% current yield. Iíll take this secured paper in an investment grade utility over some junior bank preferreds all day. Note that this is a 27yr bond, so you have substantial interest rate exposure and the price will likely decline if rates rise further. Itís also callable in a few years, muddling the convexity picture a bit.

If you want some good carry paper, I like a something like PJA which is a trust of a Qwest Capital bonds that yields about 8%. 5yr credit default swaps on QUS Cap are trading around 150bps, so this is a pretty low risk credit. The catch is that itís callable at the current price, so your principal upside is minimal. You can also take a look at trusts like JZV (10yr CNA paper), PJL (17yr Verizon paper), and KTN (13yr AON paper) which are similar. These are nice in a retirement account, where you can clip that 8% tax free.

Want to make a contrarian play? A lot of bond closed-end funds (CEFs) have taken a vicious pounding, trading at double digit discounts to net asset value (NAV), the worst theyíve seen since the financial crisis. Unlike buying stocks when they fall, this is truly buying assets at a discount (to the tune of 10-15% cheap to the underlying assets). On a fair value basis, many are 2-3 standard deviations cheap. If and when the asset class normalizes, youíll have a very fair wind at your back. Many yield well north of 7% and contain predominantly investment grade assets. Though, at the moment youíre catching a falling knife. Expect to quickly be either a hero or a zero. I think funds like ERC, BTZ, GDO, NPI, CSI, SGL, BKT, and PIM are worth taking a look at. My general criteria are greater than 11% discount to NAV, greater than 2.4 standard deviations cheap to historical NAV deviation, and a sub 1% management fee.