Aviance’s Walker on High Yield Preferreds

For this post, we interviewed Aviance Capital’s Jeffrey Walker on using high yield preferred stocks (preferreds) in a portfolio that has a specific yield target, such as 4%. Jeffrey is Director of Qualitative Research and Portfolio Manager at Aviance.

Do you view preferreds more as a fixed income investment or an equity investment?

We view preferreds more as a fixed income investment due to their established coupon payments, par value, and elevated position in a firm’s capital structure. We typically buy preferreds for their current level of income rather than looking for capital appreciation. It is important to note that each preferred can have unique characteristics, but as an asset class, we treat them as fixed income instruments.

What are the potential benefits of including preferreds in a portfolio largely consisting of traditional fixed income instruments?

We believe the largest potential benefit in including preferreds is the improved yield-to-volatility or yield-to-quality measures when compared to traditional fixed income instruments like bonds. For example, if we compare preferreds and bonds with similar levels of volatility, the preferreds have historically exhibited higher yields and better quality.

How do you utilize high yield preferred ETFs, like SPFF, within a target income portfolio?

We utilize high yield preferred ETFs in an effort to achieve an elevated level of income over broad preferred benchmarks.  We find that it’s a useful way of isolating high yield exposure, and therefore allows us to manage risk in an effort to increase income.  We view it similarly to utilizing a high yield fixed income ETF as a complement to a broad fixed income fund.

How do you approach achieving Aviance’s portfolios’ yield targets? Do you barbell exposures by combining high and low yield investments or are you focusing on securities with yields similar to your target.

If opportunities exist within our desired spectrum of risk, we will concentrate our holdings around our desired level of yield.  But what’s important to us is to diversify the sources of that yield, in an effort to achieve a high level of risk-adjusted income.  In some instances, however, we could be more tactical and utilize low yield, more conservative securities for smaller allocations. We could also tactically use higher yielding securities when we feel the landscape can continue to support the yield.

In February, we saw credit spreads widen for high yield preferreds due to spillover effects from cheap oil. Subsequently, we’ve seen those spreads contract and high yield preferreds perform well relative to broader preferred benchmarks. How do you view the risks in high yield preferreds relative to the broader preferred space? 

High yield preferred strategies can have more commodity exposure than broad preferred benchmarks. Currently, we feel comfortable overweighting high yield preferreds as it adds an element of diversification to a portfolio that consists primarily of traditional fixed income and more traditional preferred exposures.  We consider the additional risk of high yield securities, fixed income or preferred, very carefully.  High yielding securities in appropriate quantities can complement an income-oriented portfolio, however moves to allocate above these considered maximums are tactical in nature to us.  Our top priority is to generate income, but we must also be careful to manage volatility.