Preferred Stock Owners Start 2019 with a Bang
By: Tim McPartland,
Preferred stock and baby bond owners saw 2019 usher in huge gains in share prices as well as a break from a painful 2018, which brought broad and steep losses.
Gains of 2-4% were not unusual during the first week of trading in 2019 for preferred stock holders. In contrast, 2018 saw the average $25/share preferred stock fall by a full 10%.
We wrote last month about the rough year income investors holding preferred stocks had endured without knowledge that we would see shares continue to fall an additional 2%. If one received a 6% average dividend from these issues in 2018, the income investor would have ended the year with a total return of a negative 4%.
This loss serves as a reminder to income investors that even relatively conservative investing entails risk. Nonetheless, the selling that was observed in 2018 came to a halt as buyers finally stepped forward to purchase what seemed to be incredible bargains that were created during the December sell-off.
Shares which had coupons in the 6-7% range were now trading at current yields of 7-8% or even higher, which meant that substantial increases in income could be locked down. Additionally, because shares which had been trading around $25 fell, in some cases, to the $22 a share area, preferred stock issues with $25 “call prices” are positioned for potential capital gains.
We personally had been invested primarily in “term preferred stocks,” which have maturity dates in the next five years, along with baby bonds that have less than $1,000 in face value and mature within the same time frame. Because these holdings have “date certain” maturities, our portfolio incurred losses which were less severe than those incurred by perpetual preferred stockholders. The perpetual preferred stock has no state maturity date.
Just the same, we are disappointed to have incurred an overall loss of 0.5% for 2018. Our model portfolios of short duration securities, which we maintain on the DividendInvestor.com site, also incurred losses during the last couple of months of 2018. These models are meant to educate conservative investors to the benefit of holding primarily shorter-dated maturity securities during times of rising interest rates. The longest running model can be found here and was originally conceived late in 2014.
For 2019, we will delve into the perpetual preferred stock (which lack maturity dates) arena a bit to allow us to increase our income by owning some preferred issues with higher current yields because of the December sell-off. Of course, this increases our risk a bit as these perpetuals will have more interest rate risk that could cause share prices to fall in the future. We will mitigate this interest rate risk by continuing to hold substantial amounts of shorter maturity term preferreds and baby bonds, while purchasing only small amounts of the perpetual preferreds to start out. Over time, if interest rates remain favorable, we will add to the perpetual preferred holdings.
With the above in mind, we have purchased positions in the perpetual preferreds of a couple large REITs (real estate investment trusts). We have added shares in VEREIT (NYSE:VER) 6.70% perpetual preferred (NYSE:VER-F), which carries a current yield of just over 7%. Additionally, we have added the Brookfield Property REIT 6.375% perpetual preferred (NASDAQ:BPRAP), which carries a current yield of 6.85%, although it was just over 7% at the time of purchase.
With the addition of these issues, we move our portfolio income up just a bit as the current yield on our portfolio is in the 6% area. While the increase in income is small overall, over time we will likely add more perpetual preferreds, which will have higher current yields. To move quickly into higher yields would be to take more risk than we are willing to assume at this point in time.