With yields highest and spreads widest since the Global Financial Crisis, now may be an attractive entry point into the preferred and capital securities asset class.

Freepik

Opportunities for upside and higher income potential exist for the asset class now, especially within the contingent convertible (CoCos) subset of the market.

Over the past couple of years, CoCos have increasingly made up more of the preferred and capital securities universe. As of March 31, 2023, CoCos made up 42.4% of the preferred and capital securities market, up from 32.7% as of December 31, 2015 – so the landscape is not what it used to be, and we believe there is uncommon value in CoCos today.

The focus on CoCos

1. Higher income potential

CoCos have been repriced down to previous crisis levels and are currently discounted. This sets the stage for attractive income potential.

2. Historical outperformance, weathering multiple market stress periods

Due to their high level of income, CoCos have performed well since inception of the index on December 31, 2013, compared to Corporate and Treasurys, and we believe they will continue to outperform over the long term despite the current market volatility.

3. Predominate coupon structures can help manage interest rate risk and elevate prices from today’s deep discounts

Fixed-to-floating and fixed-to-variable-rate (also known as fixed-to-fixed reset) are the predominate coupon structures within the CoCos market. As these structures are callable, absent a decline in credit, prices tend to gravitate to par and then either reset at the new coupon structure or are called at par, creating stability in the market and an opportunity for appreciation. We believe the coupons may reset from the 4% area up to within a 7-8% range just a few years from now, elevating prices from today’s deep discounts.

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