Preferred Stocks: Performance, Volatility And Risk-Adjusted Returns

Dividend Yield of the 5 Largest Preferred Stock ETFs

Source: Yahoo! Finance

For context, the S&P 500 Index currently has a dividend yield of 2.0%.

Looking at total returns, preferred stocks have delivered satisfactory returns over most time periods. The past year has been particularly impressive with two of the preferred share ETFs delivering total returns above 10%.

Annualized Returns of Preferred Stock ETFs

Source: Yahoo! Finance

As expected, the performance of preferred stocks has lagged the performance of common stocks and beaten the performance of bonds over each of the time periods under consideration.

Preferred shares have also delivered returns above international stocks over the long run, which is impressive considering the higher volatility that comes from owning international stocks.

Annualized Returns by Asset Class

Source: Yahoo! Finance

Preferred stocks have performed exactly as one would expect in recent years – in between stocks and bonds.

However, risk-conscious investors are concerned with more than just absolute performance. High-volatility securities will always look like strong performers if the right time period is selected. That’s one reason why volatility is important.

The next section will compare the volatility of preferred shares to other financial instruments.

Comparing Volatility

Before conducting an analysis of the volatility of preferred stocks, I feel I must touch on the importance (or lack thereof) of volatility in investing.

Investors are generally divided when it comes to the importance of portfolio volatility.

On the one hand, volatility shouldn’t matter if an investor never sells their stocks. Day-to-day movements in stock prices have no effect on returns if one’s holding period is 5, 10 or 20 years.

Related: On Long-Term Systematic Investing

In practice, though, volatility should affect an investor’s portfolio management decisions.

There is empirical evidence that low-volatility stocks tend to outperform high volatility stocks (which would lead to fantastic risk-adjusted returns as measured by the Sharpe ratio).

This is why The 8 Rules of Dividend Investing ranks stocks by their long-term volatility and beta – because this metric has historically reduced risk and increased returns.

Volatility also allows investors to purchase stocks at a more attractive valuation if they view downward price movements as buying opportunities. I often think back to this quote from Michael Lewis‘ The Big Short, where he writes of hedge fund manager Michael Burry:

“[Burry] gave a talk in which he argued that the way they measured risk was completely idiotic. They measured risk by volatility: how much a stock or bond happened to have jumped around in the past few years. Real risk was not volatility; real risk was stupid investment decisions.

‘By and large,’ he later put it, ‘the wealthiest of the wealthy and their representatives have accepted that most managers are average, and the better ones are able to achieve average returns while exhibiting below-average volatility. By this logic a dollar selling for fifty cents one day, sixty cents the next day, and forty cents the next somehow becomes worth less than a dollar selling for fifty cents all three days. I would argue that the ability to buy at forty cents presents opportunity, not risk, and that the dollar is still worth a dollar.” (emphasis my own)

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