With heightened global market uncertainties this year, the Federal Reserve has hinted the U.S. could be in for an extended low-rate environment. Consequently, yield-starved investors may consider alternative income-generating assets, like preferred stocks and related exchange traded funds.
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On Tuesday before Congress, Federal Reserve Chairwoman Janet Yellen urged caution on the the interest rate hike path, especially ahead of the United Kingdom's referendum on whether or not it will remain within the European Union, citing "economic consequences that would be relevant to the U.S. economic outlook."
Moreover, Yellen signaled that the Fed may not be want to be caught off guard by weak growth again - the central bank was seen as too trigger happy when it first hiked rates last December ahead of slowing domestic growth and international uncertainties, such as concerns over faltering Chinese growth and a plunge in oil prices. With some lingering international troubles, Yellen indicated that the Fed sees no pressure for raising rates soon.
Before firing off another interest rate hike, the Fed will wait on improving U.S. economic growth, strengthening employment numbers and no negative shocks from a Britain June 23 referendum. Fed officials will meet again on July 26, 27.
Consequently, investors can expect the continuation of the low-rate theme. However, with most traditional fixed-income and dividend-paying equity assets trading at elevated levels, ETF investors may consider alternative sources of yield, like iShares U.S. Preferred Stock ETF (NYSE:PFF) and PowerShares Preferred Portfolio (NYSE:PGX). PFF has a 5.74% 12-month yield and PGX has a 5.75% 12-month yield.
Preferred stocks are a type of hybrid security that exhibit both bond- and equity-like characteristics. Most of the shares are issued by financial institutions, along with some utilities and telecom companies, among others. Within the securities hierarchy, preferreds are senior to common stocks but junior to corporate bonds, which gives the asset category a little greater security that equities. Additionally, preferred stocks issue dividends on a regular basis, but investors are unlikely to enjoy capital appreciation on par with common stocks.
Given an extended low interest rate outlook, preferreds may continue to generate attractive returns. While preferred stocks provide investors with an attractive source of yields, potential investors should keep in mind that the assets are vulnerable to rising interest rates. If rates rise, the holdings decline in price to elevate their yield to attractive levels. Furthermore, most preferred stocks are either perpetual or long-dated, which exposes investors to rate risks.
Nevertheless, investors still concerned about an interest rate hike out of the Feds and the potential negative fallout on rate-sensitive assets like preferreds, an investor may turn to the the PowerShares Variable Rate Preferred Portfolio Fund (NYSE:VRP) in a rising rate environment. Variable-rate preferreds typically trade more like bonds with shorter durations, so more conservative investors may find the lower rate-risk profile more appealing. VRP has an effective duration of 3.83 years, rebalancing its portfolio on a monthly basis, and shows a 5.01% 12-month yield.
This article was provided by our partners at etftrends.com.