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I Think Preferreds and Baby Bonds are Being ‘Crowded Out’

I spite of some super attractive yields in even investment grade preferreds and baby bonds they can get no traction–at least to the upside. It seems that in spite of tons of liquidity folks simply would prefer to take a inferior yield to have the comfort of CDs and Treasuries.

Some in the comments in the past have referred to the ‘crowding out’–I think the treasury is going to crowd everyone out with their massive issuance of debt at rates that make the risk/reward for the nervous nellies seem mighty attractive.

I mean you can get over 6.5% on WR Berkley debt – to me one of the highest quality insurance company’s out there, but no one wants it. Folks simply do not want the duration risk of an instrument that matures 30 or 35 years in the future.

I understand everyone that chooses ‘safety’ – it has been much less painful to be in the shorter duration instruments than the perpetuals—if I had 100% allocated to perpetuals right now I would be mighty low–contrary to many here I fixate on capital balances instead of income streams–just can’t help it.

19 thoughts on “I Think Preferreds and Baby Bonds are Being ‘Crowded Out’”

  1. One can say that the WR Berkley bond really doesnt have a lot of relative even now. As you can get a 20 yr UST at 5.31% as I type. That even adding in YTM is a fairly skimpy spread. Im like you Tim in I want income and capital preservation (increase). Its worked out pretty good this year thanks mostly to the first 4 months of the year. Everytime I buy a CD or equivalent, the money boat floats smoothly down the river. Anytime I buy a perpetual it springs a holes in the boat. I get in a few trades that bails the water out, and then suddenly another hole in the boat starts to take on water. Im still just not too excited yet in this area. But the 10-20 year HQ senior unsecured bond market is somewhere I am watching with a bit more interest. Watchful waiting mostly.

    1. Grid, Actually ran the numbers yesterday on capitulating all to that same 20-year treasury at 5.32%. It was more of a game, but the (big) surprise came in that it wasn’t a concrete “no.”

      Current Accounts are:
      Preferred: 31% yielding 6.33%
      CDs/Bonds/Treasuries/IBonds: 35% yielding 5.21% (based on entry)
      Equity Derivatives: 24% yielding 9.86%
      Cash/MM: 10% yielding 4.99%
      Overall 6.61% (near all lower-risk A-paper)

      I think we tend to bend our decisions around the total income, which suffers a sizable 20% discount under the 20-year treasury option. However, the question I’m asking myself is if that 1.3% spread (that’s all it is) over risk-free (20-year Treasury) is enough to justify the carried risk and time-investment v walking away. LT rates are beginning to become compelling.

      Let it sit for now and instead bought a stack of Duke 2037 Notes (26442CAA2) with a 6.40% YTM. Actually an add to an existing hold and was able to average-down the cost/up the combined yield just a bit.

      Thinking about all the investors in the early eighties that balked at 15% LT Treasuries because they thought they were going higher. Not sure how far out the buy point might be on those 20-year treasuries, but with the aid of risk-free lenses, it’s now visible on the horizon.

      1. Alpha, You are overthinking my thought, because I cant think that deeply, ha. It wasnt about having best returns, yield, or even being an investment to buy (which a 20 year tbill isnt on my radar either). It was just an observation of relative risk reward in relation to the yield spread. Everything is subjective to ones preferences and biases, mine included. Now when the senior unsecured of Spire of 20 year duration got to 7.35% YTM I did buy some of that a week or so ago. For an actual bond that is stretching to the furthest end of duration I will take. And I will not be overloaded at that duration either being the bond market is too thieving to trade much there.

        1. Grid, Yes that’s it exactly. All about that yield spread but subject to one’s preferences, and for some of us – deciding when to lock-for-longer.

          Best guesses and instinct might apply here as for all of us those best opportunities are most accurately identified after they’ve gone by.

  2. BDCs were asking 11-12%…..up from 6-7 going into the latest spike in rates. I think 12-14 is the next level. Which begs to ask why we would only settle for a 6.5 ytc with 10 year period uncertain AND a short call involved….for say new BAC 10 yr offerings. Higher for longer is a common refrain I’m hearing.

    Still every single mutual fund wholesaler and money manager we hear is all about ‘buying duration’…..No equity ideas at all….While I am HODL for better or worse I’m only buying pfds with a short fixed …to float call date. a 9%+ with sofr +3.5 to 4.0.

    The sense is there’s unquantifiable risk in banks. If BAC can be sitting on a 100 billion dollar loss w/ hold to maturity portfolio what the heck else is out there in CRE? So what that means is build your lists of buys and make sure you have the cash and the conviction if we blow thru lower levels in the next shakedown!

  3. There are high IG bonds out there paying up to 6.875% and many slightly above 6%. (Duration approximately 5 to 13 years.) Every investor has his “target income” I presume so a high IG bond at these rates is superior to a perpetual preferred or baby bond maturing in 30 years, even if those have a higher rate. If you are a hold-to-maturity investor I think the bonds are a better choice than preferreds right now (with a few exceptions). A few years ago we were scraping for yield. Eventually rates will go down (somewhat?) and preferreds will rise but for right now to me this seems to be the golden age for income investors.

  4. I own those perpetuals and I’m still up for the year because I’ve defended my positions. I just keep on swapping on the long and on the short side, trying to diminish the loss of long side principal.

    I add on the down drafts and lighten up on the few upswings (like yesterday). If I live long enough, the odds are that I’ll have my income and catch some nice cap gains. The saving grace is that they can’t go below zero :->0

  5. I’m hoping we can get near Covid lows with the next recession or bear market on preferreds / BB…on paper up over 30% on SB-D + SB-C, DSX-B, SCE-H, TNP-F, and CMRE-D. Recently bought KKRS BBB+ rated 7% current yield.

  6. Tim, I understand your trepedation re balances. As a rule you probably know I ignore the balances and do focus on income (has now risen for 48 consecutive months). However, during a recent consolidation of accounts to Fidelity, had to look at balances and had a bit of a moment – but let it go after I realized the income could overcome the account deficit (mostly from perpetuals) in about 93 days.

    Added to treasury holdings yesterday and again today. With an “overfull” 1-year ladder, have begun to stretch out the treasury duration into 2-year. If yields surge, everything is still short-term (=< 2 years) enough to make sense; enables rollover possibilities with no ultimate loss of capital. At some point, maybe today, we’ll all need to decide whether to continue to stretch out the duration.

    Also continuing to add small batches to A-rated perpetuals north of 6%. Seeing these as having asymmetrical risk, but for once – in our favor. What we would have done for these only 12-months ago! First, the quality v yield is best in years and do not need or necessarily want to ever sell them. If rates continue to rise, can continue to buy more – especially given the quality. If for any reason rates collapse the cap gains will be large and if called, the YTC would be off-the-charts.

    Imagine if we could today lock-down our accounts into 30-year treasury at 6.75%? Sounds appealing, though if we get there, we’ll be looking for more! Much like we’re now doing with the 5% treasury. At some point, maybe, it’ll roll-over and we’ll be lamenting not locking more for longer.

    Best to all.

    1. I gotta get me a set of your blinders, A… lol. It’s so much easier to see my account’s balance than it is to see what the actual income stream is. Maybe then I could have one of your moments in reverse and crow more about my income stream than kvetch about my portfolio balances….. Now if I could more easily see or focus in on that then maybe I wouldn’t be so mark to market conscious and feel like this year’s been not much more than a spinning my wheels year.

    2. So true. I remember about just getting a safe 3.5% yield and I’d be happy, then 4, now 5. Guess we’re never really happy!

  7. Tim, I agree.

    A lot of the junkier preferreds are not close to 52 week lows.

    Many simply don’t realize that they can get much higher quality for only a slight decrease in risk.

    And don’t get me started on equities…

  8. I feel most investors are like my kids. They want something when everyone has it and when no one wants it neither do they.

    So people were buying when yields were low. Now that you can actually make some decent coin from a preferred/BB they no longer want it.

    No different when the stock market crashes and people sit on the sidelines. Same exact thing. Just follow the herd, listening too much to talking heads on the news/web, and not making choices that fit your own personal needs.

    1. I am one of those that was buying when yields were lower and I am down quite a bit on paper in some holdings. I have added to some of those to lower my average cost and increase my yield. I also own a few that have managed to not veer to far away from my purchase price.

      I am trying to build an income stream and focus on the increasing income from reinvesting dividends/interest, but these paper losses can be disheartening at times,

  9. I think the market is pricing in the risk of capital loss for preferreds (potential loss if rates continue higher and/or lower prices in recession). Or…in other words, there is not strong conviction of potential capital gains, to place a bet on preferreds over CDs.

    Cheers! WIndy

  10. I think the crowding out that’s going on right now is the still huge sums of liquidity locked up in equities. This despite the equity risk premium basically dropping to zero, indicating dismal forward returns. Eventually we’ll see a flood of money flee to the safety of bonds. But could take a while.

    1. All the reasons for “crowding out” above are possible.
      Another possibility…….

      Our preferreds have the same risk/return qualities as term bonds.
      When yields fall, preferred’s prosper.
      Vice versa.

      What if Mr. Market is beginning to contemplate the possibility of :

      “higher for longer”
      increase of the term premium (historically 140bps 2-10T)
      increase of the risk premium (historically 300 bps gov-BBB corp)

      What preferred would look good in that environment?

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