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How Preferred Shares Have Performed Over the Past Decade

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.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.
Investigating the correlation of preferred-stock funds with the S&P 500 over the past 10 years shows that they are weakly positively correlated (correlation coefficient of 0.59). That means adding preferred equities to an all-equity portfolio might reduce overall risk a little bit.

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Bonds appear to offer more in this area. Over the past 10 years, long-term bonds are negatively correlated with the S&P 500 and therefore provide great diversification benefits to an all-equity portfolio.

With every negative look backward in time, there can be a positive outlook going forward. For example, if an investor wants to overweight financials in a portfolio but doesn’t fully believe in the strength of financials’ common equity due to the low-interest-rate environment (flat yield curve), then the high dividend payments of preferred stock might be enticing.Similarly, with interest rates at 1% in the bond market and uncertainty high in the stock market due to oil prices and the coronavirus, some investors might be seeking shelter from the storm. If they believe in the strength of the banking sector, then preferred-stock funds might be worth considering. 

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