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11/20/13 Is Now a Good Time to Buy Preferred Shares? - WSJ.com

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Now  May  Be  a  Good  Time  to  Buy  Preferred  Stock

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Nov.  10,  2013  5:06  p.m.  ET

QAre  preferred  shares  a  good  investment  in  this  market  and  are  they  closer  to  bonds  orstocks?

APreferred  shares  are  complex  investments  that  have  similarities  to  both  equities  anddebt.  Preferred  shares  trade  like  stocks  and  are  a  claim  on  the  assets  and  earnings  of  acompany,  just  like  common  shares.  But  they  hold  a  higher  claim  on  the  assets  thancommon  stock.  That  makes  preferreds  a  somewhat  safer  investment.

While  preferred  shares  usually  don't  have  voting  rights,  they  pay  a  regular  dividend  thatcan  be  substantial,  making  them  similar  in  some  ways  to  bonds.  Dividends  paid  bypreferred  shares  usually  must  be  paid  out  before  common  shareholders  receive  theirdividends.

"Preferred  shares  are  slightly  more  like  bonds  than  stocks  as  their  historical  price  volatilitymore  closely  matches  that  of  bonds,"  says  Andrew  Zimmerman,  chief  investmentstrategist  at  DT  Investment  Partners  LLC.  Just  like  bonds,  they  can  be  called  by  theissuer  in  times  of  falling  interest  rates,  Mr.  Zimmerman  notes.

"Since  preferred  shares  are  sensitive  to  interest-­rate  movements,  their  prices  fall  wheninterest  rates  rise  and  vice  versa,"  he  says.  "However,  since  they  offer  such  relativelyhigh  yields,  the  income  component  of  preferred  shares  can  help  to  offset  the  price  declinein  periods  of  small  interest-­rate  spikes."

There  are  good  reasons  for  investors  to  focus  on  preferred  shares  today,  analysts  say.

Interest  rates  remain  puny,  making  the  dividend  yields  of  many  preferred  shares  attractive.Some  professional  investors  also  are  becoming  excited  about  preferred  shares,  partlybecause  they're  wary  of  putting  too  much  money  in  a  stock  market  that  remains  near  all-­time  highs  and  is  expensive  based  on  some  metrics.

Mostly  FinancialsAlthough  most  preferreds  are  issued  by  financial  companies,  a  sector  that's  still  inrecovery  mode,  their  yields  may  make  up  for  the  risk  of  betting  on  financials.

At  the  same  time,  the  market  for  preferred  shares  isn't  widely  followed  by  Wall  Streetanalysts  and  can  be  complicated,  making  it  easier  sometimes  to  find  bargains.

"There's  downside  but  you  get  a  great  yield,  and  with  the  stock  market  at  expensivelevels,  getting  7%  or  8%  isn't  the  worst  idea  in  the  world,"  says  Bradley  Golding,  amanaging  director  at  New  York  investment  firm  Christofferson,  Robb  &  Co.,  whichspecializes  in  investing  in  financial  companies.

Mr.  Golding  says  dividends  paid  on  preferreds  issued  by  taxpaying  entities,  such  asbanks,  are  considered  "qualified"  dividends.  Much  like  dividends  on  common  stock,  thesedividends  are  taxed  at  a  lower  rate  than  regular  income,  making  them  more  attractive.

Investors  buying  preferred  shares  in  a  taxable  account  should  focus  on  qualified  dividends

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Mr.  Zuckerman  is  a  reporter  for  The  Wall  StreetJournal  in  New  York  and  author  of  "The  Frackers:  TheOutrageous  Inside  Story  of  the  New  BillionaireWildcatters."  He  can  be  reached  atgreg.zuckerman@wsj.com.

so  they  can  access  this  lower  rate,  Mr.  Golding  says.

The  risk  to  preferreds  is  similar  to  that  of  equities—the  issues  could  run  into  trouble,making  dividends  less  secure  and  pressuring  the  value  of  the  share  price.  Anotherdanger:  Preferreds,  like  bonds,  generally  do  poorly  in  a  rising-­rate  environment.  That'sbecause  their  yields  become  less  attractive  on  a  relative  basis  as  bond  yields  rise.Investors  convinced  the  U.S.  Federal  Reserve  will  begin  raising  rates  next  year  should  becautious  about  owning  too  many  preferred  shares,  analysts  say.

Comparative  PlusBut  with  the  yield  on  10-­year  U.S.  Treasury  bonds  paying  a  skimpy  2.6%  or  so,  it  makessense  to  buy  preferred  shares  sporting  yields  of  7%  to  8%,  some  advisers  say.

Other  advantages  of  preferreds:  It's  easy  to  track  their  prices,  and  they  trade  frequently,allowing  investors  to  exit  easily.

Some  investors  note  that  some  preferred  shares  have  fallen  in  price  in  recent  months,amid  nervousness  about  when  the  Federal  Reserve  will  push  rates  higher,  making  someof  these  investments  more  attractive.

One  reason  that  referred  shares  aren't  as  popular  as  common  shares:  There  are  differenttypes  of  preferreds,  which  can  be  confusing.  Convertible  preferred  shares  are  closer  toequities  because  they  allow  an  investor  to  convert  shares  into  a  fixed  number  of  commonshares  at  a  certain  date.  Other  preferred  securities  pay  a  floating-­rate  dividend,  or  one  thatmoves  with  interest  rates,  while  others  allow  an  issuer  to  suspend  a  dividend  paymentwith  no  requirement  to  pay  back  missed  dividends.

"Unlike  bonds  whose  coupon  payments  are  legal  obligations  of  the  issuing  company,  thequarterly  dividends  paid  by  preferred  shares…can  be  suspended  by  the  company  at  anytime,"  Mr.  Zimmerman  says.

It's  important  for  an  investor  to  read  offering  materials  carefully  before  diving  into  thepreferred-­stock  pool.  Considering  a  mutual  fund  or  an  exchange-­traded  fund  that  buyspreferred  shares  is  another  option.

"The  preferred  market  is  a  diverse  and  complex  one,"  notes  Mitchell  Stapley,  chiefinvestment  officer  of  Fifth  Third  Asset  Management  Inc.  and  manager  of  TouchstoneFlexible  Income  Fund.  "Investors  are  probably  wise  to  use  a  fund  structure  where  theycan  have  an  experienced  manager  of  preferreds  run  their  money."

Bull  ScenarioKeep  in  mind  that  preferred  shares  generally  don't  do  as  well  as  common  shares  in  a  bullmarket,  such  as  the  current  one  in  the  U.S.

That's  why  some  advisers,  such  as  Matthew  Tuttle,  president  of  Tuttle  TacticalManagement  LLC  in  Stamford,  Conn.,  think  investors  should  be  cautious  about  preferreds,despite  current  circumstances.

Says  Mr.  Tuttle,  "Anything  that  pays  interest  will  be  subject  to  the  whims  of  the"  FederalReserve."

Mr.  Zuckerman  is  a  reporter  for  The  Wall  Street  Journal  in  New  York.  He  can  be  reachedat  greg.zuckerman@wsj.com.

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