Mitchell Stapley, CFA, has an interesting theme for yield-seeking investors: preferred stocks, an intriguing and counterintuitive recommendation, given the environment of rising interest rates.
Stapley, who manages the Touchstone Flexible Income Fund (MXIIX), has roughly 40% of its assets in preferreds.
(The fund has about $294 million of assets and has earned a four-star rating from Morningstar on its institutional shares.)
As expected, recent rate increases have created headwinds for preferreds.
The S&P U.S. Preferred Stock Index produced a -5.69% price return year to date through Sept. 6; the total return was -1.49% for the same period.
Through Aug. 31, MXIIX had a total return of -1.66% for its institutional shares. (The S&P Preferred Index is not an exact benchmark for the fund because the fund holds other fixed-income investments.)
What's Stapley's rationale for buying preferreds?
He cites several factors. The first is that his firm believes we've already experienced most of the expected interest rate increase.
Historically, he says, 10-year rates have a tendency to migrate toward the level of nominal GDP growth. Rates can move temporarily above and below that level but eventually trend back to it.
"As we get towards 3.25%, and given the fact that we've come off of the 1.42% low, we've done more than two-thirds of the work," he says. "That's kind of our central tendency for rates right now, somewhere around 3.25%, give or take, plus or minus. But it's not 4%, it's not 5%, and the only way we get to that 4% or that 5% is if we would get some kind of real sharp uptick in economic activity."
If you see that development, Stapley requests, let him know. "That's not in my crystal ball or too any prognosticators' out there," he admits.
Preferreds' yield advantage over straight debt securities is another attractive feature, according to the fund manager. He cites cumulative securities issued by JP Morgan (JPM) as examples.
