One of the most important developments of the income market over the last few months has been the interrelated dynamics of relatively persistent inflation, an increasingly hawkish Fed and the associated sharp rise in short-term rates.
In this brief post we highlight two securities that are expected to take advantage of this sharp rise in short-term rates. We do this by identifying attractive preferred stocks with relatively high reset yields.
A reset yield is simply the expected stripped yield of the stock on its first call date when its coupon switches to a floating-rate, if left unredeemed by the issuer. The idea here is that the more the Fed hikes its policy rate the more these securities will benefit if/when their coupon floats on their fist call date. And even if the securities are redeemed they will benefit not only from their attractive current stripped yields but also from the price stability and resilience that the redemption will bring.
K1-issuer MLP DCP Midstream 7.875% Series B (DCP.PB) is trading at a $23.42 stripped price with a 8.41% YTW / 8.88% reset yield with a first call date in June-2023.
mREIT AAIC 8.25% Series C (AAIC.PC), trading at a $24.49 stripped price with a 8.42% YTW / 8.92% reset yield with a first call date in Mar-2024.
High reset-yield preferreds remain attractive in the current market environment of persistent inflation, hawkish Fed and rising short-term rates.
These stocks can provide potentially attractive yields if the reality of future short-term rates is anywhere near current expectations. They can also prove to be more resilient relative to their fixed-rate counterparts in investor portfolios, anchored by the redemption possibility and high floating-rate coupons past redemption.
Judging by the basic composition of the preferreds space, most preferred investors are overweight fixed-rate preferreds and securities mentioned in this article may offer a good dose of both income upside and diversification in the current market environment.
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