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Preferreds Present ‘Outsized Risks’ and Today’s Other Top Stories

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Preferred securities have been an investor’s best friend of late due to their attractive yields in a low-yield world, but that friendship could turn sour once rates start to rise.

Wells Fargo Advisors say that preferreds are highly vulnerable to any rise in interest rates, and advises investors to scale back their preferred holdings to prevent if and when rates do rise.

Michael Aneiro, from Barron’s Income Investing blog notes that Brian Rehling, Wells’ chief fixed-income strategist, says preferreds’ traditionally high 7%-8% coupons have been refinanced across the market with lower coupons that present “outsized risks” if rates rise, and he offers a pretty sweeping cautionary note for investors:

The last several years have seen a dramatic shift in the market for preferred securities, a shift we believe is negative for investors…. Investors use the term “preferred security” as a blanket term to describe any security that typically trades with a $25 par value, has a fixed dividend and is listed on a major stock exchange…. Today the “preferred security” market encompasses a wide range of structures with meaningful differences that can have a significant impact on individual security valuations and stability. These securities… could be either senior in nature or a deeply subordinated junior security….

Regardless of subordination all of these securities have one element in common: they are generally all very long-term securities which make them sensitive to changes in interest rates. In addition, most of the new offerings in this space are coming to market with coupons that are at or near the lowest level most issuers have ever issued.

Wells went on to say that determining the specific duration, or interest-rate sensitivity, of preferreds can be “difficult and potentially misleading” due to structural issues and call options that allow the issuer to redeem the securities early, leading to “a wide variability in the timing of potential cash flows.” Wells notes that if rates fall, issuers will typically call the securities away and refinance them, making them short-duration assets during periods of falling rates, but that if rates rise issuer’s won’t call them and they become long-duration holdings.


Todays Other Top Stories

Learn Bonds

LearnBonds: – Take a look at Johnson and Johnson – A true “dividend aristocrat” – If you’re a trader, you might shy away from Johnson and Johnson (NYSE: JNJ) at the moment. The giant healthcare products stock gave up six-plus points in 10 days this month after hitting its all-time high at $106.47 on July 7. But it’s not the traders I’m addressing right now – it’s long-term investors.


Municipal Bonds

Forbes: – Supply-demand dynamics should support muni market. – Despite the headline news surrounding a small handful of municipal issuers, the muni market has performed well this year and remains underpinned by strong supply and demand dynamics. It’s one of the key themes identified by the MacKay Municipal Managers (MMM) team at the beginning of the year and, if anything, it’s playing out even more decisively than they predicted.

Bidness Etc: – Will Wells Fargo and other large banks be affected by the new liquidity rule? – With the new liquidity rule set to be approved by US regulators, it will be interesting to see how it will impact Wells Fargo and other major banks.

Philly.com: – Derivative deals making comeback for municipalities. – Local governments in Pennsylvania are turning again to the kinds of derivative deals that backfired during the credit crunch, as the lure of up-front cash and the potential to cut costs prove hard to resist.

Citywire: – Making the most of munis: three experts clash on sector outlook. – The high profile bankruptcy of Detroit left many investors wary of the municipal bonds but as Barclays moves to aid the downtrodden city, has sentiment shifted?

Bloomberg: – Bank liquidity rules seen cooling demand for bonds. – Regulatory changes aimed at heading off another financial crisis may curb purchases of municipal bonds by banks, potentially undermining demand from the biggest buyer in the $3.7 trillion market.

Zacks: – Dump these funds as municipal bonds may lose liquid status. – According to a Bloomberg report, municipal bonds may no longer be a part of banks’ easily sellable assets following a ruling on Sept. 3rd. Regulators, which include the Federal Reserve, are likely to approve a final liquidity rule next week that will exclude the said asset class from banks’ easily sellable assets. This may be a huge move as it will affect banks, municipal bodies and definitely investors of these bonds.


Bond Market

Market Realist: – Why bond investors are focusing on credit ratings and quality. – High-yield bond funds have seen some wild swings lately. A record of $7.1 billion was withdrawn in the week ending August 8. In the week ending August 15, some of those flows reversed. Net flows into junk bond funds were positive because overseas risk perceptions receded. Investors also appeared to have oversold the asset class the previous week. They looked to get back into the market at lower valuations.

MarketWatch: – Beware the enormous bubble in bonds. – There’s a saying on Wall Street: Stocks are for show, but bonds are for dough. The flash, sizzle and focus of financial reporting typically center on stocks. But the real action and the biggest players are over in the world of bonds. While there are a fair number of warning signs now that the free money policies of the world’s central banks have given us another stock bubble, they’re outnumbered by the flashing red lights we see over in the bonds market.

Bloomberg: – What happened in July stayed in July as bond gains return. – One month after talk that the 30-year bull market in bonds was ending, it’s business as usual.


Treasury Bonds

Market  Realist: – Why Treasury auctions impact investors and financial markets. – The U.S. Treasury Department issues Treasury securities to finance government debt. Maturities on the Treasury securities vary. Treasury securities are sold to institutional and retail investors. These auctions are the U.S. Treasury’s main supply source.


Investment Grade Bonds

Market Realist: – Why high-grade issuers stayed away from capital markets. – Despite favorable market conditions, high-grade corporate bond issuance was muted in the week ending August 15. Issuance volumes dropped by 33% over the prior week. A total of $16.7 billion was issued over 17 transactions in the corporate investment-grade bond market in the week ending August 15.


High Yield Bonds

Scott Arterburn: – Who has the better junk….bonds? – HYG and JNK are the largest high yielding corporate bond ETFs. They look to be very similar. SO why does HYG always seems to beat JNK?

Businessweek: – U.S. junk bond funds get $671.5 million in third weekly inflows. – Investors deposited $671.5 million into U.S. high-yield funds the past week, the third straight inflow following a record withdrawal, according to data provider Lipper.

Dismal Scientist: – High-yield bond market risks rise in U.S. (Subscription required) High-yield bond returns have been extraordinary over the past few years. Their value has more than doubled since 2009, and annual returns have surpassed the S&P 500 in three of the previous six years as investors plowed money into the segment. High-yield interest rates and their spreads with Treasuries are near record lows.


Investment Strategy

USA News: – 4 Reasons why investors should be careful with bonds. – The case for bonds having a poor long-term forecast has only strengthened in the past year.

MarketWatch: – With bond boom ending, switch into these alternatives. – It’s been a pretty good year for bond investors, considering. Sure, yields are in the cellar, but thanks to a dip in interest rates since January, people have actually made money on bond investments. The thing is, though, bonds aren’t going to be a great investment for long.

Market Realist: – Why bond investors are focusing on credit ratings and quality. – High-yield bond funds have seen some wild swings lately. A record of $7.1 billion was withdrawn in the week ending August 8. In the week ending August 15, some of those flows reversed. Net flows into junk bond funds were positive because overseas risk perceptions receded. Investors also appeared to have oversold the asset class the previous week. They looked to get back into the market at lower valuations.

Market Realist: – Looking toward non U.S. bonds. – Heading into 2014, all the talk was of a higher interest-rate environment here in the U.S. The 10-year Treasury note climbed to 3 percent, everyone was proclaiming that the end of the bull market in bonds was near, and numerous market participants had shortened duration of their bond portfolios.


Bond Funds

ETF.com: – About $15B flows into U.S. ETFs in August. – Investors plowed about another $15 billion into exchange-traded funds so far this month and, together with the S&P 500 Index rising to the 2000 milestone, total assets in U.S.-listed ETFs rose 3 percent to date in August to a record of more than $1.909 trillion.

ETF Channel: – 10 top performing ETFs. – A look at the top 10 best performing ETFs over the past twelve months.

Reuters: – Pimco Total Return bond fund beats 76 pct of peers in August-Morningstar. – Bill Gross’s Pimco Total Return Fund, the world’s largest bond fund, rose about 1.1 percent in August to beat 76 percent of its peers, preliminary Morningstar data showed on Friday.


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