Preferred Stocks: Performance, Volatility And Risk-Adjusted Returns

Related: How Uncertainty Helps Dividend Investors

With all that said, investors should be pleased by the low volatility of preferred stocks. Each of the five largest preferred stock ETFs has historical volatility numbers well below common stocks.

Annualized Volatility of Preferred Stock ETFs

Source: Yahoo! Finance

Note: The 10-year volatility numbers are much higher than other time periods because preferred experienced large price fluctuations during the Great Recession of 2008-2009 as investors fled to safer asset classes.

The volatility of various asset classes is compared to preferred stocks in the following diagram.

Annualized Volatility by Asset Class

Source: Yahoo! Finance

During all time periods (other than the 10-year, which is skewed by the financial crisis) preferred stocks had lower volatility than all financial instruments other than bonds. This is exactly what would be expected, given the characteristics of preferred stocks.

For investors looking for a low volatility alternative to preferred stocks that still offers strong total return potential, click here to see a list of the top 15 low volatility Dividend Aristocrats.

Comparing Risk-Adjusted Returns

Risk-adjusted returns (as measured by the Sharpe Ratio) allow investors to simultaneously assess performance and volatility. The Sharpe Ratio tells an investor how much additional performance is generated for each incremental unit of risk assumed.

The Sharpe Ratio is calculated as:

Sharpe Ratio Calculation

There is much debate over what is an appropriate metric to use for the risk-free rate of return. Given that interest rates are near zero right now, this analysis will use a risk-free rate of return of 0%. One could also use the 3-month t-bill yield which is currently below 1%.

As expected, preferred stocks have delivered excellent risk-adjusted returns. The Sharpe Ratios of the five largest preferred stock ETFs over various time periods is listed below.

Annualized Sharpe Ratio of Preferred Stock ETFs

Source: Yahoo! Finance

The Sharpe Ratios of preferred stocks is compared to domestic common stocks, domestic bonds, and international stocks in the following diagram.

Annualized Sharpe Ratio by Asset Class

Source: Yahoo! Finance

Judging from this data, preferred stocks appear to have the strongest risk-adjusted return potential of any asset class if we exclude the biased data from the Great Recession of 2008-2009.

Final Thoughts

Preferred stocks offer investors the opportunity to diversify away from typical common stock investments. They also offer lower volatility and fantastic risk-adjusted returns.

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