Reiterating the Case for Preferred Securities

Recent challenges from higher rates and banking turmoil are well known to investors in preferred securities, but the performance of this asset class relative to other alternatives in fixed income may not be. Here’s why we think preferreds continue to offer attractive total return potential and a tax-advantaged income stream.

Understanding preferred securities

Preferreds are fixed income securities with characteristics of both debt and equity. Like debt, they carry a credit rating and have a set face value and a predetermined coupon. As with equities, issuers can defer or suspend payments, and the instruments typically carry perpetual or long-dated maturities. They do come with additional risk from subordination and sector concentration, which the regional banking stress in early 2023 made clear.

Despite their subordination, preferreds are primarily investment grade (IG) rated. Ratings agencies tend to notch the rating for preferreds lower than the issuer’s senior bond, based on their methodology. Whether senior, subordinated or preferred, these credit instruments are rated on the same ratings scale. Default rates for preferreds have averaged less than 1% annually, as is the case for similarly rated corporate bonds.

For these features, preferreds have historically paid among the highest yields in the IG fixed income universe.