By Samuel Taube
Transcript:
Samuel Taube: Joining us by phone is Alexander Green, the Chief Investment Strategist of The Oxford Club. And today, we’re talking about the unique assets known as preferred shares.
Alex, thanks for joining us again.
Alexander Green: Thanks for having me, Sam.
ST: From what I understand, preferred shares aren’t exactly like a regular stock. They’re not exactly like a bond. What are they?
AG: Technically, they’re called hybrid securities. That means they have qualities of both stocks and bonds. For instance, they don’t have voting rights like a stock, but yet you do have an actual equity stake in the company.
And dividends are prioritized to be paid to preferred shareholders before common shareholders. That’s how it gets the “preferred” label. Also, in the unlikely event of a corporate liquidation, preferred shareholders stand in line ahead of holders of common stock.
So they have qualities of both stocks and bonds, but they have lots of advantages, especially in the sort of volatile markets we’ve seen lately.
ST: And given this kind of hybrid characteristic, how do preferred shares fit into your ideas about asset allocation? Do you treat them as a stock or a bond as far as portfolio makeup?
AG: Well, it’s actually an entirely different asset class and a surprisingly under-owned one, Sam. Most people I talk to don’t own any preferred shares at all.
And that’s unfortunate because they have lots of advantages. For instance, they’re far less volatile than individual stocks, so they have lower risk. They have regular quarterly payouts, and those payouts are much higher than the ones on common stocks.
For instance, right now, the S&P 500 is yielding about 2.3%. But the average preferred share yields almost three times as much – around 6%. And sometimes you see yields of 8%, 9%, 10% or more.
It’s very difficult to earn that kind of a yield in today’s market and have capital appreciation potential as well.
ST: That’s a powerful combination. You mentioned these shares are less volatile than regular stocks. Given their common characteristics with bonds, are they sensitive to changes in interest rates?
AG: They are interest rate sensitive because the yields are so high. Unlike bonds, most preferred shares don’t have a maturity date. They either will never mature or sometimes won’t for as many as 50 years.
But they also get more favorable tax treatment than bonds do. Interest on a taxable bond is taxable at your top marginal income tax rate, which can be as high as 39.6% (37% as of January 2018).
But the taxes on preferred shares are like common stock dividends. It’s a maximum of 20% plus the 3.8% “Obamacare” surcharge.
So you get higher income. You get preferred tax treatment. You have lower risk, but you still have great upside potential.
ST: It’s pretty clear why these are called preferred shares. They seem to have a lot of advantages. What have preferred shares done during this recent equity correction? Have they sold off less?
[iu-adbox]
AG: They hardly budged, Sam. You can pull up, say, the preferred shares iShares ETF. …read more
Source:: Investment You
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