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While the preferred stock (PFF) led the income pack in 2012 with a total return of 18.2%, the...

While the preferred stock (PFF) led the income pack in 2012 with a total return of 18.2%, the current risk-reward profile isn't great, says Barclays' Shobhit Gupta, with the upside capped by the issuer call option, and significant downside if rates rise. One overlooked class for investors: Convertible Bonds (CWB). Barron's overview of the income sector.
Comments (26)
  • Regarded Solutions
    , contributor
    Comments (15432) | Send Message
     
    There is plenty of diversification in PFF to withstand the call option while rotating into other stocks. I completely disagree with Gupta, which would not be the first time this genius was completely wrong!
    6 Jan 2013, 09:17 AM Reply Like
  • Tack
    , contributor
    Comments (12684) | Send Message
     
    Convertibles and floating-rate issues look attractive in this environment. A few ETF's to consider:

     

    Convertible:
    NCV
    AGC
    JPC
    CHI

     

    Floating:
    PFL
    VVR
    PHD
    JRO
    6 Jan 2013, 09:23 AM Reply Like
  • Petrarch
    , contributor
    Comments (625) | Send Message
     
    Tack - the fees for all of these are ruinous and excessive.

     

    I would rather own CLMS and rake in the fees.

     

    P
    6 Jan 2013, 01:31 PM Reply Like
  • Tack
    , contributor
    Comments (12684) | Send Message
     
    Pet:

     

    I'd suggest you reconsider:

     

    One year performance to shareholders, including dividends and net of fees:

     

    NCV - 12%
    AGC - 11%
    JPC - 32%
    CHI - 14%

     

    PFL - 28%
    VVR - 25%
    PHD - 15%
    JRO - 17%

     

    I'll be happy with all of those performances for non-equity funds.

     

    CLMS - -5% (that's "minus")
    6 Jan 2013, 01:52 PM Reply Like
  • Derek A. Barrett
    , contributor
    Comments (3534) | Send Message
     
    Thanks Tack, you always find the hidden gems.
    7 Jan 2013, 01:41 AM Reply Like
  • PalmDesertRat
    , contributor
    Comments (2565) | Send Message
     
    CWB is an interesting idea.

     

    My concern is that the largest sector exposure there is financials,which have been on a real tear recently. In a market correction they would tank,so it wouldn't surprise me if cwb underperformed the market.
    6 Jan 2013, 10:05 AM Reply Like
  • Tack
    , contributor
    Comments (12684) | Send Message
     
    Bank preferreds would be very unlikely to tank or even move significantly in a correction. They only get hit when large liquidity panics set in. That seems most unlikely, now.
    6 Jan 2013, 10:33 AM Reply Like
  • Regarded Solutions
    , contributor
    Comments (15432) | Send Message
     
    I agree Tack, which is why Gupta has no clue to what he is talking about.
    6 Jan 2013, 10:40 AM Reply Like
  • MexCom
    , contributor
    Comments (3050) | Send Message
     
    But the problem are calls. The real good ones are already at a premium. What is preventing something like the Citi preferred that gets below par to be bought up from them just buying it back on the open market. The grand yield is gone and then there is nothing left behind to reinvest the proceeds. I'm putting all my preferred call proceeds into common stocks picking small banks rated B or better at Schwab yielding better than 2%. EOY selling is compete on these and I've hit home runs before with the strategy to pick the ones that were trounced EOY. My best hit was 2 years ago with BKYF.
    6 Jan 2013, 01:23 PM Reply Like
  • Tack
    , contributor
    Comments (12684) | Send Message
     
    Mexcom:

     

    There's never any risk if one holds an issue below par. They can't force you to sell it back below par. The risk, if any, is when issues are above par, in which case one needs to study the prospectus to see what the call provisions and dates are.
    6 Jan 2013, 01:55 PM Reply Like
  • PalmDesertRat
    , contributor
    Comments (2565) | Send Message
     
    I'm sure you're right,but my comment was about CWB which is made up of converts.
    7 Jan 2013, 07:30 AM Reply Like
  • Zheeeem
    , contributor
    Comments (256) | Send Message
     
    2012 was a great year to sell preferred stock. At the moment preferreds are somewhat overvalued as a class, as is junk. The higher yielding preferreds are disappearing quickly from redemptions, and new IPOs of good quality stuff is in the 5-6% range. As long as the Fed keeps rates low I think this space will stay crowded, but after that? Convertibles? Depends on the issue.
    6 Jan 2013, 10:53 AM Reply Like
  • whaddyamean?
    , contributor
    Comments (514) | Send Message
     
    I, too, have the semi-irrational fear that interest rates will rise in the foreseeable future and thus inflict pain upon fixed income investors. In addition, the mobs that flock to solid 4%-dividend-paying stocks are likely to abandon ship when rates eventually rise, thereby lowering the tide that supposedly raises all boats. Floating rate preferred stocks might provide a safe haven in a rising-rate environment, but there is some concern about the time-lag between an increase in interest rates and a corresponding adjustment in the floating rate instrument. So, in which direction can retirees turn for a relatively safe investment that offers greater reward than a CD or a T-bill? I'd like to put my money to work intelligently, but this lofty objective ain't as easy to accomplish as it used to be.
    6 Jan 2013, 11:01 AM Reply Like
  • Zheeeem
    , contributor
    Comments (256) | Send Message
     
    Not sure it's an irrational fear. Rates go up, rates go down. But I doubt the Fed will let rates skyrocket with GDP growth slow and unemployment still high.

     

    I am still OK with preferreds, but have reduced my holdings somewhat. I loaded up heavily in late 2009/early 2010 with some high yielding european stuff from ING, Barclays, HSBC, DeutscheBank and Santander (and a few US bank preferreds). Most of it I have rolled out of at a very good profit (I'll sell the SAN-E after another dividend or two, the DKT on the other hand, is not callable for another 5 years.) I have reinvested some of it in lower yielding stuff like GS-I, RF-A, SCE-F and NEE-C. A small part I have then used to buy small amounts of more speculative stuff like MILL-C and MHR-D. (And some even more speculative convertibles like APA-D and CHK-D.) I also keep my eye on the IPO market.

     

    I reduced my preferred (and junk bond) weighting by about 20%, and most of the proceeds went to a combination of MLPs and dividend stocks that Mr. Market had put on sale. There's always something on sale.
    6 Jan 2013, 11:41 AM Reply Like
  • Tortoise #1
    , contributor
    Comments (412) | Send Message
     
    whaddy, Finding appropriate income investments never was easy. However, my experience is that holding dividend-growth stocks for long-periods has proved rewarding both in terms of dividend stream growth and appreciation of price.

     

    Will the portfolio value decline during economic recessions? Of course! But, the dividends will likely continue and make holding tolerable!

     

    I did so during the market declines of 2000/2002 and
    2007/03/09/2009. In both examples, we had price value recovery.

     

    You simply have to have faith that after the value declines, there will be recovery!

     

    This optimism saved this 86 year old from exiting equities in 2008 and putting the money in "safe" places such as bank savings, C.D.s and money market funds and are now earning virtually nothing on these investments and are having to sell assets to meet their living expenses!

     

    I offer the above to give younger investors encouragement!
    6 Jan 2013, 11:47 AM Reply Like
  • Hillbilly Stock Star
    , contributor
    Comments (726) | Send Message
     
    Kinda surprised they missed GDV 5% monthly payer!
    6 Jan 2013, 02:39 PM Reply Like
  • George Fisher
    , contributor
    Comments (1428) | Send Message
     
    Hill,

     

    One of my fav is GABUX which is an income fund disguised as a uts fund with a merger/buyout focus. Distribution is about 13% monthly, of which a vast majority is ROC. Very misunderstood.
    6 Jan 2013, 04:26 PM Reply Like
  • PalmDesertRat
    , contributor
    Comments (2565) | Send Message
     
    Looking at the web site for pff I cannot tell what duration is.

     

    I guess it's safe to assume all the issues in the portfolio are fixed rate.
    6 Jan 2013, 03:48 PM Reply Like
  • Tack
    , contributor
    Comments (12684) | Send Message
     
    Preferred stocks don't have a duration.

     

    PFF is mostly preferred shares, but they can be floating or convertible, too, and they own some bonds:

     

    http://bit.ly/WA88ST
    6 Jan 2013, 03:58 PM Reply Like
  • PalmDesertRat
    , contributor
    Comments (2565) | Send Message
     
    Auction-rate preferred, variable rate,etc all affect duration.
    6 Jan 2013, 06:22 PM Reply Like
  • Tack
    , contributor
    Comments (12684) | Send Message
     
    PDR

     

    Very few preferreds have maturities. Without maturity there is no duration.
    6 Jan 2013, 06:48 PM Reply Like
  • PalmDesertRat
    , contributor
    Comments (2565) | Send Message
     
    Duration also measures sensitivity to interest rate changes. In that sense maturity is irrelevant. Variable/adjustable rate preferreds will have an impact if there are enough of them in the portfolio.
    6 Jan 2013, 07:43 PM Reply Like
  • Ray Merola
    , contributor
    Comments (3073) | Send Message
     
    Benjamin Graham noted that preferred stocks are only worthwhile investments when they can be purchased at a discount to par.

     

    I bought into PFF back in 2009 when the world was going to come to an end. The fund bounced nicely over the years, but I sold out in 2012 to take advantage of the cap gains rate and the fact that the underlying share price is unlikely to go much above $40, unless interest rates decline. I thought that would be a weak premise.

     

    On the other hand, I like convertibles. My investment vehicle is the Vanguard Convertible Securities Fund (VCVSX). The current yield is 3.7 percent and the expense ratio is 0.59%. YE 2012 all-in performance was 14.77% (Morningstar). I've owned shares of this fund likewise since 2009.

     

    My view is that when the difference between the fund yield and Aaa bonds (FRB data) is greater than 2 percent, it's time to bail. Today, the diff is 0.1%. Plenty of headroom.
    6 Jan 2013, 04:43 PM Reply Like
  • linkdonald
    , contributor
    Comments (473) | Send Message
     
    I had a closed end convert fund when I opened a Roth IRA in 2004. One thing I found out was that they are more volatile than they appear. Also, good management is critical as many convertible choice are start-up companies with dicey prospects. This on top of those who are trying to swing a creative" financing" that may or may not pay off. All that said, these funds are probably worth a small flyer if for no other reason than that they are better bets than some of the more speculative offerings out there.
    6 Jan 2013, 09:14 PM Reply Like
  • Hillbilly Stock Star
    , contributor
    Comments (726) | Send Message
     
    Thanks Jon, I deep digging in utes.
    6 Jan 2013, 09:36 PM Reply Like
  • toomuchgas
    , contributor
    Comments (535) | Send Message
     
    I'd like to hold more cash if I could afford the 0% interest rate.
    26 Feb 2013, 10:13 PM Reply Like
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