President Trump has been talking about tariffs since 1989, when he advocated for a 15% to 20% tax on imports from Japan because of unfair trade practices. This is how he describes Canada, China, Mexico and Europe today.
Trump has already imposed a 10% levy on Chinese imports. Meanwhile, Mexico and Canada have secured a 30-day reprieve from planned 25% tariffs, contingent upon their commitments to bolster border security and curb the flow of illicit drugs into the United States.
More tariffs are coming. Trump says he is willing to take the short-term pain for potential benefits.
We contrarians don’t have to grit our teeth and suffer with stocks that are suddenly tariff losers. We will continue to sidestep companies with supply chain risk as we load up on a backdoor bullish play: bonds.
The 10-year Treasury yield has traded lower since the initial tariff news. Here’s why—tariffs are a short-term headwind on growth. Contrary to popular belief that these levies are inflationary, a recent study shows otherwise. The Centre for Economic Policy Research found that tariffs do not boost inflation because rising prices depend on a hot economy—and a trade war does the opposite.
The Financial Times recently reached a similar conclusion. Yes, tariffs compress company margins due to upward wage pressure and higher costs. But these are typically absorbed by the firms—and their shareholders!
Bond investors agree. The 10-year yield has yet again hit its head just below the “5% ceiling.” If tariffs were really inflationary, wouldn’t the bond market have freaked out and demanded higher yields? The opposite has happened:
In a steady-to-falling long rate environment, we are happy to own bonds and their proxies—such as preferred stocks and their fat payouts.
Preferreds are called “hybrid” investments because they share qualities of both common stock and bonds. For instance, we buy preferreds on a stock exchange (like common stocks), and they represent ownership in a company (like common stocks). But their dividends are fixed (like bonds), they’re extremely sensitive to interest rates (like bonds), and their price activity is much more similar to bonds.
And as a general rule, as bonds go, so go preferreds.
However, our best way to buy isn’t through individual preferreds, but closed-end funds (CEFs).
Preferred CEFs not only enable us to diversify across hundreds or thousands of preferred shares by purchasing a single fund—they also allow us to buy those preferreds at a discount to their net asset value (NAV). Plus, rather than doing the digging ourselves, we’re offloading the work to one or more expert managers. Not a bad deal!
For example, here are three preferred CEFs currently yielding between 6.9% and 10.5% that we can buy on the cheap.
Cohen & Steers Limited Duration Preferred and Income Fund (LDP)
Distribution Rate: 7.5%
Discount to NAV: 4.9%
I want to start with an oddity in the preferred space: the Cohen & Steers Limited Duration Preferred and Income Fund (LDP).
The view from 10,000 feet isn’t anything abnormal. LDP isn’t U.S.-centric, but a “global” preferred portfolio, split roughly 55/45 between domestic and international preferreds. It’s heavy in financials, which is par for the course. Credit quality is similar to a standard vanilla preferred fund.
Where things start to get weird is the “limited duration” objective. The average preferred stock is perpetual in nature. In other words, it doesn’t have an expiration date, so duration isn’t really part of the picture. But LDP owns preferreds that do have listed maturities, and it explicitly targets those preferred shares that have low duration, which should help reduce interest-rate risk.
Gauging that is a little difficult. This Cohen & Steers fund’s average modified duration is 4.5 years (an oversimplified explanation: a percentage-point hike in interest rates would clip LDP’s price by 4.5%). Well, many preferred funds don’t even list a duration, though for what it’s worth, the Morningstar category average for preferred-stock funds is nearly 6 years, and that’s riskier than LDP.
We also get a couple of other meaningful differences:
- A heaping helping of debt leverage (33%) that helps LDP’s managers really swing for the fences on its high-confidence calls, not to mention juices its 7%-plus monthly dividend.
- A roughly 5% discount to NAV that’s a little cheaper than its historical discount.
Historically, all of the above has led to a more turbulent chart than its ETF peers, but a bigger pot of gold at the end of the rainbow.
Flaherty & Crumrine Preferred Securities (FFC)
Distribution Rate: 6.9%
Discount to NAV: 6.8%
Flaherty & Crumrine Preferred Securities (FFC) is a pretty standard-issue preferred CEF. The financial sector is about 80% of assets, but 25% is wrapped up in insurance companies, which don’t have the same liquidity issues some banks can run across if customers decide to withdraw all at once.
It’s also a global fund—FFC has a larger U.S. allocation (70%), but there are still plenty of big foreign financials from developed countries represented here, including BNP Paribas (BNPQY), Banco Santander (SAN) and Societe Generale (SCGLY).
Overall credit quality is a little lower than DFP and most standard preferred ETFs, with about 5-10 percentage points less in investment-grade preferreds.
And management is downright aggressive with leverage, which is just south of 40% right now.
As one might imagine, lower credit quality and high leverage has historically led to a lot of wobble in this fund, but long-term, the wobble has been more than worth it.
FFC’s pricing has been all over the place—its five-year average is just 1%, but it traded at a double-digit discount within the past year. It currently sits roughly in between right now, at about 93 cents on the dollar.
Nuveen Variable Rate Preferred & Income Fund (NPFD)
Distribution Rate: 10.5%
Discount to NAV: 4.9%
Preferreds offer high yield, but it’s still extremely rare to see a double-digit payout in the space. But that’s not the only reason Nuveen Variable Rate Preferred & Income Fund (NPFD) is so interesting.
While many preferred stocks pay a fixed dividend, some are issued with variable rates. NPFD homes in on these and other variable-rate income-producing securities. That said, the lion’s share of its assets aren’t in true floating-rate securities. Roughly three-quarters of assets are invested in “fixed-to-fixed rate securities,” which step from one rate to another based on a set schedule. Another 15% or so are in fixed-to-floating rate securities, which start with a fixed coupon that it pays for a few years before switching to a variable-rate coupon. Only about 4% of the fund is invested in pure variable-rate preferreds.
Past that, the portfolio is a 65/35 U.S./international blend of primarily financial stocks. Credit quality is quite high—nearly 75% of assets are investment-grade, including nearly 10% in A-rated preferreds. And it’s also happy to use plenty of debt (37% leverage at present) to double down on its investments and boost its monthly distribution.
Yet at first glance, it would appear that this Nuveen fund isn’t quite up to snuff with FFC and LDP.
But context is key. Remember: 2022-23 was brutal for preferreds as a whole! This CEF simply had the misfortune of coming to life on Dec. 15, 2021, just before the market for preferred stocks took a nosedive. In fact, it’s the only one of these three funds to sport a positive total return since NPFD’s inception date.
That said, Wall Street isn’t sleeping on NPFD anymore. Within the past year, shares could be bought for 85 cents on the dollar—but now that discount sits at a slimmer 5%.
Brett Owens is Chief Investment Strategist for Contrarian Outlook. For more great income ideas, get your free copy his latest special report: Your Early Retirement Portfolio: Huge Dividends — Every Month — Forever.
Disclosure: none
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