Yields on these income-producing assets can top 6%. Here are UBS' top picks in preferred securities

UBS recommends preferred securities for long-term income investors, citing their hybrid features, tax advantages, and supportive market dynamics despite muted year-to-date performance for $25 par issues (-0.6% vs. $1,000 par up 3.5% as of June 24). Frank Sileo of UBS notes that a lack of competitive yield alternatives, strong banking sector fundamentals (major issuers), and favorable supply-demand dynamics underpin their appeal. He emphasizes the importance of diversifying into $1,000 par preferreds to improve risk-adjusted performance and reduce correlation, while suggesting a combined approach of single-security and ETF investments for tailored solutions.

Analysis

UBS presents a constructive outlook on preferred securities for long-term income investors, citing supportive fundamentals despite mixed performance year-to-date. The asset class is buoyed by a lack of competitive yield alternatives, solid banking sector fundamentals—critical given that banks represent two-thirds to three-quarters of issuance—and favorable supply-demand dynamics. A significant performance divergence has emerged as of June 24, with institutional-focused $1,000 par value preferreds gaining 3.5% YTD, while retail-oriented $25 par issues have declined by 0.6%, a weakness attributed to their higher correlation with equity market trends. This disparity underscores the UBS recommendation for 'intra-sector diversification' to improve risk-adjusted returns. While broad market ETFs like PFF and PFFD offer attractive 30-day SEC yields of 6.57% and 6.52% respectively, the note cautions that these funds often have limited exposure to the outperforming $1,000 par segment, suggesting a more tailored approach combining ETFs with single-security selection is optimal.

Key Decisions for Investors

• Investors holding preferred security ETFs like PFF or PFFD should assess their portfolio's limited exposure to the outperforming $1,000 par value segment and consider adding individual institutional-grade issues to enhance diversification and potentially improve risk-adjusted returns.
• For income-focused portfolios, preferreds offer compelling after-tax yields relative to traditional bonds, but investors should prioritize a blended strategy of ETFs and single securities to gain tailored access to the entire asset class.
• Given that up to 75% of preferred issuance comes from banks, the fundamental health and capital adequacy of the financial sector remains the primary macro factor to monitor when holding these securities.