Rate reset preferred shares remain undervalued and can provide investors with an important vehicle to help negotiate end-of-cycle risk.
That’s the view of Alfred Lee, portfolio manager and investment strategist at BMO Global Asset Management – Canada, who highlighted three key themes for investors to be mindful of at a BMO “The Road Ahead” breakfast event in Toronto.
Lee said the return of volatility, higher rates and political turmoil will all translate into uncertainty and confusion in the market. He believes having a simple portfolio is vital for investors and that, in a rise-rate environment, it’s important to have a component that directly benefits from these hikes. Rate reset preferred shares, he said, are made for the job.
He said: “You could be thinking to yourself, well, rate resets have had a tremendous run the last three years so how much upside is left?
“One thing to keep in mind is that, as interest rates go up, the upside for rate resets continue to go up as well. Overall, if you look at the overall American rate reset in general, they are still undervalued as a whole.”
Lee signposted the BMO US Preferred Share Index ETF (ZUP) as performing this function and, with a 6.7% yield, as a capable alternative to high-yield bonds.
He added: “Any time you invest in that preferred share, I recommend going through an ETF just because the liquidity advantage that it offers in that market. Our feeling about our preferred share ETF is that it’s a good way to access the rate reset market but also we ladder the rate; the portfolio will reset every year to the current interest rate environment.”
Lee said defence is another tactic investors require to protect against choppy markets, adding that equity markets at this stage of the business cycle historically tend to see some progressive gains and occasionally go parabolic.
He said: “Staying true to your asset allocation mix is going to be key. I think it’s going to be very easy for investors to get lulled into over-allocating into equities so do not forget about fixed income – I think that’s going to be key in this market.”
Despite the emphasis on defence, Lee believes investors should still have satellite positions that are boosted by a pro-growth environment, which he believes will exist for approximately the next two years.
He said: “[It’s important] to have exposure to things like US banks but also from the fixed-income side of your portfolio overweight things like corporate bonds - but keep you focus on higher quality corporate bonds.”
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