WSJ: How Preferred Shares Have Performed Over the Past Decade

Investors don’t understand preferred stock.

Some investors, for instance, think that because these investments pay fixed dividends over time, their returns should resemble the stability of bond returns. Others think that because preferred shares are “stocks,” their returns should look more like that of common stock.

So what does history tell us about the returns and risks of preferred stock? And does adding this often-misunderstood asset class to portfolios increase diversification?

Investigating the universe of U.S. preferred-stock ETFs and mutual funds over the past 10 years, we can see that preferred stocks have underperformed U.S. equities (the S&P 500 index) and even underperformed U.S. long-term bonds. U.S. preferred-stock funds averaged an annual return of 7.29% over the period, compared with 7.70% for long-term bonds and 13.52% for the S&P 500.

This underperformance of preferred stocks relative to long-term bonds is mitigated by the fact that preferred stocks have exhibited less volatility over the past 10 years. But a look at the 2008 financial crisis shows that preferred stocks are exposed to a particular type of risk that bonds aren’t: crash risk in times of crises.

In 2008, preferred shares behaved much more like common stock in terms of their propensity to plummet. While the S&P fell 38% in 2008, preferred-stock ETFs and mutual funds lost an average of 25.1%. Contrary to this, long-term bonds gained 8.7% in returns over the same period.

The huge difference in returns between bonds and preferred stock is partially explained by the fact that most preferred-stock funds have significant exposure to banks, which suffered big losses in 2008. Financial institutions are a primary issuer of preferred equity, and preferred-stock funds still average 75% of their holdings in issuances by insurance companies, banks and real-estate groups.

When thinking about preferred stock — or any asset class — investors also should consider its diversification benefits. The main way to do that is to look at the correlation of its returns with the S&P 500’s returns.

Read the full piece at:

https://www.wsj.com/articles/how-preferred-shares-have-performed-over-the-past-decade-11591454236