Rate Cuts Aren’t Guaranteed; Consider Preferred Stock ETF VRP
These days, forecasting what the Federal Reserve has in store for interest rates feels like a futile endeavor. Consensus wisdom indicates the central bank is highly unlikely to cut or raise rates this month, but after that, it’s anyone’s guess.
That lack of clarity is frustrating for many income investors, particularly those with exposure to higher-yielding, rate-sensitive assets, such as preferred stocks and the related ETFs. Preferred stocks allow market participants to remain in the income game while mitigating rate risk. Enter the Invesco Variable Rate Preferred ETF (VRP).
The $3.01 billion VRP, which tracks the ICE Variable Rate Preferred & Hybrid Securities Index, turned 12 years old in May. It’s a potentially ideal way to remain engaged with preferred stocks — an income-rich asset class, but also one prone to rate-sensitivity.
A Good Time to Consider VRP
VRP holds 350 preferred stocks and answers the income bell, as highlighted by a 30-day SEC yield of 5.49%. That point underscores this ETF’s allure to income investors.
“Preferred stock may appeal to income-focused investors because it can offer a more predictable dividend profile and lower price volatility than common stock,” noted Saxo Group.
Obviously, VRP has an eye-catching yield. But what’s even more impressive is how the ETF defrays rate risk. The fund has an effective duration of 3.03 years, which is lower than that found on many competing ETFs. It’s good enough to put VRP in short-term territory in bond parlance. The Invesco fund arrives there because it holds floating rate preferred stocks. In the fixed income world, floating rate securities are among the least rate-sensitive assets.
All this talk about rate risk is a reminder that preferred stocks, including those held by VRP, are hybrid securities. That means they share both equity and fixed income traits. Sticking with the bond side of the equation, investors need to be mindful credit risk with preferred stocks. However, VRP mitigates some of that risk, as 83% of its holdings are rated AA, A or BBB.
At the sector level, market participants new to preferreds should note that financial services issues loom large in this space. VRP is indicative of that, as that sector accounts for 92.27% of the fund’s portfolio. That heft has some positives.
“Banks and utility companies tend to issue preferred shares because these industries emphasise stability and steady cash flow,” added Saxo.
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