Q&A: Interest rates and preferred shares

Question: I have been reading many articles that are recommending selling preferred shares as they claim rising interest rates will lower their value. Can you comment on whether preferreds are still an appropriate investment to hold or should we start pulling back a little? – Frank V.

Gordon Pape answers: It depends on the type of preferred. Straight preferreds (those which pay a fixed dividend) are vulnerable to rising interest rates in the same way as bonds. However, floating rate preferreds are not because their return is linked directly to a benchmark interest rate. So as rates rise, so does the dividend paid on the shares, albeit with a time lapse.

Convertible preferreds are also less vulnerable to rising rates because their market price is also directly affected by the value of the underlying common stock. The closer the stock price gets to the conversion price, the more valuable the convertible preferred will become.

he bottom line is that preferreds cannot all be lumped together. There are several different types and each will be affected differently by rate movements.

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