Historically, high yield asset classes have been vulnerable to rising Treasury yields. This includes preferred stocks – a preferred income destination.
This makes the current environment all the more difficult to navigate for income investors. Government bond yields are still low, but the Federal Reserve is set to raise interest rates several times this year, which may affect high-yielding assets.
This is probably one of the reasons many investors turn to floating rate notes and related exchange traded funds. the Invesco Preferred Floating Rate ETF (VRP) offers investors what is today an attractive combination of preferred share income and floating rate notes.
The $2.07 billion VRP, which turns eight in May, tracks the ICE Variable Rate Preferred & Hybrid Securities Index. This index includes “above-grade and below-investment grade floating-rate and floating-rate U.S. dollar preferred stocks,” according to Invesco.
With a 30-day SEC yield of 3.68%, VRP is a credible alternative to premium floating rate strategies. Speaking of credit quality, 39% of VRP’s 312 holdings carry junk rates, but that’s not a deal breaker for the fund.
“Analysis of the credit quality of floating rate ETFs highlights their different investment strategies. Investment grade floating rate ETFs, as the name suggests, hold investment grade instruments. Prime Loan ETFs invest primarily in B-rated debt, while Variable Prime ETFs offer slightly better credit quality, despite higher yields,” says Nicolas Rabener of Factor Research.
Of the various forms of variable rate debt, variable preferred shares are among the most correlated to equities, but this is not surprising, due to the equity-like characteristics exhibited by preferred shares. Yet the broader spectrum of floating rate assets, including floating rate preferred stocks, is not strongly correlated to equities, indicating that VRP may offer some portfolio diversification.
“Floating rate preferred ETFs and senior loans have high positive correlations with the S&P 500, which can be explained by the underlying portfolios, i.e. below-grade corporate bonds. investment grade that behave in the same way as equities. If a company experiences corporate stress for company- or industry-specific reasons, this can easily spread to its preferred bonds, loans and instruments,” adds Rabener.
Although more volatile, VRP has outperformed the largest floating rate, high yield and investment grade corporate bond ETFs over the past three years. The VRP also yields 118 basis points more than the widely followed Markit iBoxx USD Liquid Investment Grade Index.
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