Lowering Duration With Preferred Securities
Preferred Securities
Lowering Duration With Preferred Securities With the Federal Reserve moving further away from 0% interest rates and bond yields on the rise, many investors are turning to low-duration fixed income to preserve capital, often at the expense of yield. The Cohen & Steers Low Duration Preferred and Income Fund (LPXAX) offers a way to reduce interest-rate risk, while providing the potential for attractive tax-advantaged income to help investors meet their cash flow needs.
Preferred securities are often perceived as being highly sensitive to changing interest rates, as some popular preferred investments pay a fixed coupon with no maturity date, generally resulting in high durations. These types of securities dominate the retail exchange-listed market and tend to constitute the vast majority of holdings in exchangetraded preferred securities index funds. However, exchange-listed preferreds represent only 19% of the preferred securities universe. The rest are traded in the institutional over-the-counter (OTC) market, which consists
Reduced Sensitivity to Rising Interest Rates In contrast to most other fixed income categories, low-duration preferreds had a positive total return over the study period to the right, as modest price declines were offset by high income rates. Attractive After-Tax Income Although preferreds generally trade as debt, many are considered equity for tax purposes, paying qualified dividend income (QDI), which is taxed at a lower rate. Using a conservative assumption that 50% of the securities are QDI eligible, low-duration preferreds offer an after-tax yield of about 3.5% for investors earning less than $479K annually—comparing favorably to many other fixed income categories, including those with much higher durations.
As shown below, low-duration preferreds defended better than other fixed income categories in the latest period of rising Treasury yields, while providing after-tax income that was in line or better than many intermediateduration investments.
Impact of a Sharp Rise in the 10-Year Treasury Yield 9/7/17 (2.05%) to 2/28/18 (2.87%), 82 Basis Points Over Six Months 4% 2% Total Return
Note: The date range selected represents the only period of meaningful increases in Treasury yields since the inception of the lowduration preferred securities index(a) on 10/29/15.
largely of securities with coupon resets, such as fixed-tofloating-rate and floating-rate securities. Since the payments can reset as rates rise, the durations of these securities can be much lower. In fact, 68% of the $948-billion preferred universe has a duration of 5 years or less, while 41% has a duration of 3 years or less.
0%
0.7
0.8
-2% -4% -6%
Yield Before Taxes After Taxes < $479K/yr (i) > $479K/yr (j)
-1.9
-0.9
-1.2
-6.0
-8%
Average Duration
-1.4
-7.5 Low-Duration Preferred Securities(a)
U.S. High Yield(b)
30-Year Treasury(c)
10-Year Treasury(d)
Municipal Bonds(e)
Corporate Bonds(f)
Low-Duration Municipal Bonds(g)
Low-Duration Corporate Bonds(h)
2.5
3.8
20.0
8.7
5.0
7.1
2.5
2.8
4.5%
6.2%
3.1%
2.9%
2.6%
3.7%
1.8%
3.1%
3.2% 3.1%
3.8% 3.8%
1.9% 1.9%
1.8% 1.8%
2.6% 2.6%
2.3% 2.3%
1.8% 1.8%
1.9% 1.9%
At February 28, 2018. Source: Morningstar Direct, Cohen & Steers. Data quoted represents past performance, which is no guarantee of future results. The information presented above does not reflect the performance of any fund or other account managed or serviced by Cohen & Steers, and there is no guarantee that investors will experience the type of performance reflected above. Yields shown on a yield-to-worst basis. Preferred securities after-tax yield calculations assume income is taxed at the respective qualified dividend rate and marginal tax rate on a 50/50 blended basis. All other securities reflect full taxation at the respective marginal rates based on income. (a) ICE BofAML 8% Constrained Developed Markets Low Duration Capital Securities Custom Index (credit quality: BBB-). (b) ICE BofAML U.S. High-Yield Index (Credit quality: B). (c) ICE BofAML Current 30-Year US Treasury Index. (d) ICE BofAML Current 10-Year US Treasury Index. (e) ICE BofAML Municipal Master Index (Credit quality: AA-). (f) ICE BofAML Corporate Master Index (Credit quality: A-). (g) (1-5 Year) ICE BofAML Municipal Master Index (Credit quality: AA-). (h) (1-5 Year) ICE BofAML Corporate Master Index (Credit quality: A-). (i) For individuals (married, jointly filing) with income exceeding $400k but less than $479k, qualified dividend income is taxed at 18.8% and the marginal tax rate used was 38.8%. Both rates include the Medicare surcharge of 3.8%. (j) For individuals (married, jointly filing) with income exceeding $479k but less than $600k, qualified dividend income is taxed at 23.8% and the marginal tax rate used was 38.8%. Both rates include the Medicare surcharge of 3.8%. See back page for index definitions and additional disclosures.
Preferred Securities
Gaining Access to Low-Duration Preferreds
An Experienced Team
While a few low-duration preferreds exist in the exchangelisted market, most require access to the OTC market through an institutional manager. By working with Cohen & Steers, investors are connected to a large and experienced team of preferred securities specialists. With offices in Hong Kong and London, Cohen & Steers has greater ability to invest in preferred securities than firms that cannot freely participate in such transactions without an offshore presence. Considering that 70% of the preferreds universe consists of foreign issuers, this opportunity could be meaningful.
William Scapell, Executive Vice President and Head of Fixed Income, leads the preferred securities team, with 26 years of industry experience, managing $14.0 billion across all strategies as of December 31, 2017. He is joined by a team of analysts dedicated to the asset class. Their proprietary research is supported by extensive contacts in the industry and leverages the firm’s global capabilities in large-cap value, infrastructure and global real estate securities.
Investors seeking high income with less sensitivity to interest-rate movements should speak with their financial advisor about whether low-duration preferreds are a suitable way to diversify their fixed income investments.
Cohen & Steers’ Actively Managed Low-Duration Preferred Securities Solutions Cohen & Steers Low Duration Preferred and Income Fund LPXAX—Class A LPXCX—Class C LPXIX—Class I
LPXRX—Class R LPXZX—Class Z
Index Definitions An investor cannot invest directly in an index, and index performance does not reflect the deduction of any fees, expenses or taxes. ICE BofAML 8% Constrained Developed Markets Low Duration Capital Securities Custom Index tracks the performance of select U.S. dollar-denominated fixed and floating-rate preferred, corporate and contingent capital securities, with remaining term to final maturity of one year or more, but less than five years. (1-5 Year) ICE BofAML Municipal Master Index tracks the performance of U.S. dollar-denominated investmentgrade tax-exempt debt (with maturities of 1-5 years) publicly issued by U.S. states and territories, and their political subdivisions, in the U.S. domestic market. ICE BofAML Municipal Master Index tracks the performance of U.S. dollar-denominated investment-grade tax-exempt debt publicly issued by U.S. states and territories, and their political subdivisions, in the U.S. domestic market. (1-5 Year) ICE BofAML Corporate Master Index tracks the performance of U.S. dollar-denominated investment-grade corporate debt (with maturities of 1-5 years) publicly issued in the U.S. domestic market. ICE BofAML Corporate Master Index tracks the performance of U.S. dollar-denominated investment-grade corporate debt publicly issued in the U.S. domestic market. ICE BofAML U.S. High-Yield Master Index tracks the performance of U.S. dollar-denominated below-investment-grade corporate debt publicly issued in the U.S. domestic market. ICE BofAML Current 10-Year US Treasury Index is a one-security index comprised of the most recently issued 10-year US Treasury note. ICE BofAML Current 30-Year US Treasury Index is a one-security index comprised of the most recently issued 30-year US Treasury bond. Please consider the investment objectives, risks, charges and expenses of any Cohen & Steers fund carefully before investing. A summary prospectus and prospectus containing this and other information may be obtained by visiting cohenandsteers.com or by calling 800 330 7348. Please read the summary prospectus and prospectus carefully before investing. The views and opinions in the preceding commentary are as of the date of publication and are subject to change without notice. There is no guarantee that any market forecast set forth in this presentation will be realized. This material represents an assessment of the market environment at a specific point in time, should not be relied upon as investment advice, is not intended to predict or depict performance of any investment and does not constitute a recommendation or an offer for a particular security. We consider the information in this document to be accurate, but we do not represent that it is complete or should be relied upon as the sole source of suitability for investment. Investors should consult their own advisors with respect to their individual circumstances. Risks of Investing in Preferred Securities. Investing in any market exposes investors to risks. In general, the risks of investing in preferred securities are similar to those of investing in bonds, including credit risk and interest-rate risk. As nearly all preferred securities have issuer call options, call risk, reinvestment risk and income risk are also important considerations. In addition, investors face equity-like risks, such as deferral or omission of distributions, subordination to bonds and other more senior debt, and higher corporate governance risks with limited voting rights. Preferred funds may invest in below-investment-grade securities. Below-investment-grade securities or equivalent unrated securities generally involve greater volatility of price and risk of loss of income and principal, and may be more susceptible to real or perceived adverse economic and competitive industry conditions than higher-grade securities. Risks associated with preferred securities differ from risks inherent with other investments. In the event of bankruptcy, a company’s preferred securities are senior to common stock but subordinated to all other types of corporate debt. Municipal bonds are issued and backed by state and local governments and their agencies, and the interest from municipal securities is often free from both state and local income taxes. 10-Year Treasury notes are issued by the U.S. government and are considered the safest of all bonds, since they are backed by the full faith and credit of the U.S. government as to the timely payment of principal and interest. Duration Risk. Duration, reported in years, is a mathematical calculation of the average life of a fixed income or preferred security that serves as a measure of the security’s price risk to changes in interest rates (or yields). Securities with longer durations tend to be more sensitive to interest rate (or yield) changes than securities with shorter durations. Duration differs from maturity in that it considers potential changes to interest rates, and a security’s coupon payments, yield, price and par value and call features, in addition to the amount of time until the security matures. Various techniques may be used to shorten or lengthen the Fund’s duration. The duration of a security will be expected to change over time with changes in market factors and time to maturity. This commentary must be accompanied by the most recent Cohen & Steers Fund fact sheet(s) and summary prospectus if used in connection with the sale of mutual fund shares. Cohen & Steers U.S. registered open-end funds are distributed by Cohen & Steers Securities, LLC, and are available only to U.S. residents.
Publication Date: March 2018. Copyright © 2018 Cohen & Steers, Inc. All rights reserved.
cohenandsteers.com
Advisors & Investors: 800 330 7348 Institutions & Consultants: 212 822 1620
MP837 0318
Lowering Duration With Preferred Securities With the Federal Reserve moving further away from 0% interest rates and bond yields on the rise, many investors are turning to low-duration fixed income to preserve capital, often at the expense of yield. The Cohen & Steers Low Duration Preferred and Income Fund (LPXAX) offers a way to reduce interest-rate risk, while providing the potential for attractive tax-advantaged income to help investors meet their cash flow needs.
Preferred securities are often perceived as being highly sensitive to changing interest rates, as some popular preferred investments pay a fixed coupon with no maturity date, generally resulting in high durations. These types of securities dominate the retail exchange-listed market and tend to constitute the vast majority of holdings in exchangetraded preferred securities index funds. However, exchange-listed preferreds represent only 19% of the preferred securities universe. The rest are traded in the institutional over-the-counter (OTC) market, which consists
Reduced Sensitivity to Rising Interest Rates In contrast to most other fixed income categories, low-duration preferreds had a positive total return over the study period to the right, as modest price declines were offset by high income rates. Attractive After-Tax Income Although preferreds generally trade as debt, many are considered equity for tax purposes, paying qualified dividend income (QDI), which is taxed at a lower rate. Using a conservative assumption that 50% of the securities are QDI eligible, low-duration preferreds offer an after-tax yield of about 3.5% for investors earning less than $479K annually—comparing favorably to many other fixed income categories, including those with much higher durations.
As shown below, low-duration preferreds defended better than other fixed income categories in the latest period of rising Treasury yields, while providing after-tax income that was in line or better than many intermediateduration investments.
Impact of a Sharp Rise in the 10-Year Treasury Yield 9/7/17 (2.05%) to 2/28/18 (2.87%), 82 Basis Points Over Six Months 4% 2% Total Return
Note: The date range selected represents the only period of meaningful increases in Treasury yields since the inception of the lowduration preferred securities index(a) on 10/29/15.
largely of securities with coupon resets, such as fixed-tofloating-rate and floating-rate securities. Since the payments can reset as rates rise, the durations of these securities can be much lower. In fact, 68% of the $948-billion preferred universe has a duration of 5 years or less, while 41% has a duration of 3 years or less.
0%
0.7
0.8
-2% -4% -6%
Yield Before Taxes After Taxes < $479K/yr (i) > $479K/yr (j)
-1.9
-0.9
-1.2
-6.0
-8%
Average Duration
-1.4
-7.5 Low-Duration Preferred Securities(a)
U.S. High Yield(b)
30-Year Treasury(c)
10-Year Treasury(d)
Municipal Bonds(e)
Corporate Bonds(f)
Low-Duration Municipal Bonds(g)
Low-Duration Corporate Bonds(h)
2.5
3.8
20.0
8.7
5.0
7.1
2.5
2.8
4.5%
6.2%
3.1%
2.9%
2.6%
3.7%
1.8%
3.1%
3.2% 3.1%
3.8% 3.8%
1.9% 1.9%
1.8% 1.8%
2.6% 2.6%
2.3% 2.3%
1.8% 1.8%
1.9% 1.9%
At February 28, 2018. Source: Morningstar Direct, Cohen & Steers. Data quoted represents past performance, which is no guarantee of future results. The information presented above does not reflect the performance of any fund or other account managed or serviced by Cohen & Steers, and there is no guarantee that investors will experience the type of performance reflected above. Yields shown on a yield-to-worst basis. Preferred securities after-tax yield calculations assume income is taxed at the respective qualified dividend rate and marginal tax rate on a 50/50 blended basis. All other securities reflect full taxation at the respective marginal rates based on income. (a) ICE BofAML 8% Constrained Developed Markets Low Duration Capital Securities Custom Index (credit quality: BBB-). (b) ICE BofAML U.S. High-Yield Index (Credit quality: B). (c) ICE BofAML Current 30-Year US Treasury Index. (d) ICE BofAML Current 10-Year US Treasury Index. (e) ICE BofAML Municipal Master Index (Credit quality: AA-). (f) ICE BofAML Corporate Master Index (Credit quality: A-). (g) (1-5 Year) ICE BofAML Municipal Master Index (Credit quality: AA-). (h) (1-5 Year) ICE BofAML Corporate Master Index (Credit quality: A-). (i) For individuals (married, jointly filing) with income exceeding $400k but less than $479k, qualified dividend income is taxed at 18.8% and the marginal tax rate used was 38.8%. Both rates include the Medicare surcharge of 3.8%. (j) For individuals (married, jointly filing) with income exceeding $479k but less than $600k, qualified dividend income is taxed at 23.8% and the marginal tax rate used was 38.8%. Both rates include the Medicare surcharge of 3.8%. See back page for index definitions and additional disclosures.
Preferred Securities
Gaining Access to Low-Duration Preferreds
An Experienced Team
While a few low-duration preferreds exist in the exchangelisted market, most require access to the OTC market through an institutional manager. By working with Cohen & Steers, investors are connected to a large and experienced team of preferred securities specialists. With offices in Hong Kong and London, Cohen & Steers has greater ability to invest in preferred securities than firms that cannot freely participate in such transactions without an offshore presence. Considering that 70% of the preferreds universe consists of foreign issuers, this opportunity could be meaningful.
William Scapell, Executive Vice President and Head of Fixed Income, leads the preferred securities team, with 26 years of industry experience, managing $14.0 billion across all strategies as of December 31, 2017. He is joined by a team of analysts dedicated to the asset class. Their proprietary research is supported by extensive contacts in the industry and leverages the firm’s global capabilities in large-cap value, infrastructure and global real estate securities.
Investors seeking high income with less sensitivity to interest-rate movements should speak with their financial advisor about whether low-duration preferreds are a suitable way to diversify their fixed income investments.
Cohen & Steers’ Actively Managed Low-Duration Preferred Securities Solutions Cohen & Steers Low Duration Preferred and Income Fund LPXAX—Class A LPXCX—Class C LPXIX—Class I
LPXRX—Class R LPXZX—Class Z
Index Definitions An investor cannot invest directly in an index, and index performance does not reflect the deduction of any fees, expenses or taxes. ICE BofAML 8% Constrained Developed Markets Low Duration Capital Securities Custom Index tracks the performance of select U.S. dollar-denominated fixed and floating-rate preferred, corporate and contingent capital securities, with remaining term to final maturity of one year or more, but less than five years. (1-5 Year) ICE BofAML Municipal Master Index tracks the performance of U.S. dollar-denominated investmentgrade tax-exempt debt (with maturities of 1-5 years) publicly issued by U.S. states and territories, and their political subdivisions, in the U.S. domestic market. ICE BofAML Municipal Master Index tracks the performance of U.S. dollar-denominated investment-grade tax-exempt debt publicly issued by U.S. states and territories, and their political subdivisions, in the U.S. domestic market. (1-5 Year) ICE BofAML Corporate Master Index tracks the performance of U.S. dollar-denominated investment-grade corporate debt (with maturities of 1-5 years) publicly issued in the U.S. domestic market. ICE BofAML Corporate Master Index tracks the performance of U.S. dollar-denominated investment-grade corporate debt publicly issued in the U.S. domestic market. ICE BofAML U.S. High-Yield Master Index tracks the performance of U.S. dollar-denominated below-investment-grade corporate debt publicly issued in the U.S. domestic market. ICE BofAML Current 10-Year US Treasury Index is a one-security index comprised of the most recently issued 10-year US Treasury note. ICE BofAML Current 30-Year US Treasury Index is a one-security index comprised of the most recently issued 30-year US Treasury bond. Please consider the investment objectives, risks, charges and expenses of any Cohen & Steers fund carefully before investing. A summary prospectus and prospectus containing this and other information may be obtained by visiting cohenandsteers.com or by calling 800 330 7348. Please read the summary prospectus and prospectus carefully before investing. The views and opinions in the preceding commentary are as of the date of publication and are subject to change without notice. There is no guarantee that any market forecast set forth in this presentation will be realized. This material represents an assessment of the market environment at a specific point in time, should not be relied upon as investment advice, is not intended to predict or depict performance of any investment and does not constitute a recommendation or an offer for a particular security. We consider the information in this document to be accurate, but we do not represent that it is complete or should be relied upon as the sole source of suitability for investment. Investors should consult their own advisors with respect to their individual circumstances. Risks of Investing in Preferred Securities. Investing in any market exposes investors to risks. In general, the risks of investing in preferred securities are similar to those of investing in bonds, including credit risk and interest-rate risk. As nearly all preferred securities have issuer call options, call risk, reinvestment risk and income risk are also important considerations. In addition, investors face equity-like risks, such as deferral or omission of distributions, subordination to bonds and other more senior debt, and higher corporate governance risks with limited voting rights. Preferred funds may invest in below-investment-grade securities. Below-investment-grade securities or equivalent unrated securities generally involve greater volatility of price and risk of loss of income and principal, and may be more susceptible to real or perceived adverse economic and competitive industry conditions than higher-grade securities. Risks associated with preferred securities differ from risks inherent with other investments. In the event of bankruptcy, a company’s preferred securities are senior to common stock but subordinated to all other types of corporate debt. Municipal bonds are issued and backed by state and local governments and their agencies, and the interest from municipal securities is often free from both state and local income taxes. 10-Year Treasury notes are issued by the U.S. government and are considered the safest of all bonds, since they are backed by the full faith and credit of the U.S. government as to the timely payment of principal and interest. Duration Risk. Duration, reported in years, is a mathematical calculation of the average life of a fixed income or preferred security that serves as a measure of the security’s price risk to changes in interest rates (or yields). Securities with longer durations tend to be more sensitive to interest rate (or yield) changes than securities with shorter durations. Duration differs from maturity in that it considers potential changes to interest rates, and a security’s coupon payments, yield, price and par value and call features, in addition to the amount of time until the security matures. Various techniques may be used to shorten or lengthen the Fund’s duration. The duration of a security will be expected to change over time with changes in market factors and time to maturity. This commentary must be accompanied by the most recent Cohen & Steers Fund fact sheet(s) and summary prospectus if used in connection with the sale of mutual fund shares. Cohen & Steers U.S. registered open-end funds are distributed by Cohen & Steers Securities, LLC, and are available only to U.S. residents.
Publication Date: March 2018. Copyright © 2018 Cohen & Steers, Inc. All rights reserved.
cohenandsteers.com
Advisors & Investors: 800 330 7348 Institutions & Consultants: 212 822 1620
MP837 0318
