VRP: Preferred Stocks May Be Better Than Corporate And Junk Bonds

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The Invesco Variable Rate Preferred ETF (NYSEARCA:VRP) provides vulnerability to adaptable complaint preferred equity and hybrid securities. Its humanities show has been muted, particularly successful 2022, arsenic the plus people is susceptible to higher recognition spreads, similar junk bonds and elder loans. However, the plus people does person concern merit, arsenic VRP has historically outperformed LQD and JNK some successful presumption of implicit and risk-adjusted returns. It besides has a comparable organisation output to JNK. I deliberation VRP is simply a viable alternate to junk enslaved ETFs similar the JNK.

Fund Overview

The Invesco Variable Rate Preferred ETF provides vulnerability to adaptable complaint preferred banal and hybrid securities. The VRP ETF has $1.8 cardinal successful assets and charges a 0.50% disbursal ratio.

Strategy

The VRP ETF tracks the ICE Variable Rate Preferred & Hybrid Securities Index ("Index"). The scale is designed to way the show of floating and adaptable complaint concern people ("IG") and non-investment people ("junk") preferred stocks issued by U.S. companies.

What Is Preferred Equity?

Preferred equity is simply a benignant of information that sits wrong a company's superior operation betwixt bonds and communal equity (Figure 1). In the lawsuit of a bankruptcy, preferred equity has higher assertion connected a company's assets than communal equity, but a subordinated assertion compared to debt.

Figure 1 - Preferred equity ranks little than bonds but higher than communal equity successful superior operation (royalbank.com)

Preferred equity differs from communal equity successful that determination are usually nary voting rights attached to preferred equity erstwhile it comes to firm matters. Also, preferred equity has constricted appreciation upside, arsenic they are usually issued with telephone provisions allowing the institution to redeem the shares astatine a definite price. Preferred equity typically person stated dividends (either fixed oregon floating rate) that indispensable beryllium paid earlier the institution tin contented communal banal dividends.

Compared to bonds, preferred equity usually carries a higher organisation output to compensate for their little precedence assertion successful the superior structure. However, dissimilar enslaved involvement payments, preferred equity dividends tin beryllium skipped without putting a institution into default (although this is highly frowned upon).

Portfolio Holdings

Figure 2 shows the VRP ETF's assemblage allocation and recognition prime allocation. The astir prolific issuers of preferred equity securities are fiscal companies (usually banks and security companies); hence, Financials marque up 73% of the VRP fund's portfolio.

Figure 2 - VRP Sector and Credit Quality allocation (invesco.com)

Like bonds, preferred equity issues tin beryllium rated by the standing agencies similar S&P and Moody's. 58% of the fund's portfolio is rated BBB according to S&P, and 35% is rated BB (non-investment grade).

Figure 3 shows the fund's apical 10 holdings, which relationship for 12.4% of the fund.

Figure 3 - VRP apical 10 positions (invesco.com)

Returns

Figure 4 shows the humanities returns of the VRP ETF. The money has had muted humanities returns, with 3 and 5Yr mean yearly returns of -0.2% and 2.1% respectively to December 31, 2022.

Figure 4 - VRP humanities returns (morningstar.com)

However, investors should enactment that comparative to the Morningstar money class of Preferred Stock, VRP has delivered archetypal quartile show implicit a 1/3/5Yr timeframe. So VRP's muted concern show is much of an contented with the plus people alternatively than the money manager.

Distribution & Yield

The VRP ETF pays a modestly precocious organisation of $1.20 /share successful the trailing 12 months, which equate to a 5.3% yield. VRP's organisation is paid monthly, but is adaptable and depends connected the distributions received from the underlying portfolio.

Preferred Equity Is Inversely Correlated To Credit Spreads

Given preferred equity's presumption successful the superior structure, they often commercialized similar precocious output bonds. If we overlay the terms show of the VRP ETF vs. the ICE BofA High Yield OAS Spread, we tin spot that VRP's marketplace terms declines erstwhile precocious output recognition spreads emergence (Figure 5).

Figure 5 - VRP terms is inversely correlated to recognition spreads (Author created with terms illustration from stockcharts.com)

During utmost marketplace events similar the COVID-19 pandemic successful 2020 oregon the Great Financial Crisis successful 2008, preferred equities tin get dislocated arsenic issuers elite to skip dividend payments to conserve capital.

Are Preferred Equities Better Than Junk Bonds?

If we comparison the VRP ETF to the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) representing firm bonds and the SPDR Bloomberg Barclays High Yield Bond ETF (JNK) representing precocious output bonds, we tin spot that the preferred equity plus people does person concern merit comparative to its firm and junk enslaved cousins.

Figure 6 - VRP vs. LQD and JNK (Author created utilizing Portfolio Visualizer)

Measured from May 2014 to December 2022 (since inception for VRP), the VRP ETF has delivered a higher CAGR instrumentality of 3.5% compared to the LQD and JNK ETFs of 1.9% respectively. The volatilities of each 3 funds are precise similar, with modular deviation of returns ~8%. Higher returns and akin volatilities pb to the VRP ETF having a Sharpe Ratio of 0.36, much than doubly that of LQD and JNK's 0.17 Sharpe Ratio.

In presumption of yield, the VRP ETF has a organisation output comparable to the JNK ETF, and acold higher than LQD's (Figure 7).

Figure 7 - VRP vs. LQD and JNK output (Seeking Alpha)

So for investors looking for yield, the preferred equity plus people whitethorn beryllium superior compared to the firm enslaved and junk enslaved plus classes, judging by their humanities show and organisation yields.

Conclusion

The VRP ETF provides vulnerability to adaptable complaint preferred banal and hybrid securities. Its show has been muted successful 2022, arsenic the plus people trades inversely to recognition spreads. However, investors seeking output whitethorn privation to instrumentality a look astatine the VRP, arsenic the plus people has outperformed firm bonds and junk bonds, arsenic judged by VRP's humanities show vs. LQD and JNK.

I spent 5 years arsenic a co-founder and hedge money CIO / manager. Before that, I was a hedge money analyst/portfolio manager astatine a starring Canadian alternate plus manager. I constitute articles arsenic portion of my ain owed diligence connected the stocks that I find interesting, for 1 crushed oregon another.Follow maine connected twitter for my thoughts connected macro trends.