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While investors wait for the first rate cut from the Federal Reserve, those looking for income may want to consider preferreds, according to an analysis by Bank of America. These assets, which can yield around 6%, are a hybrid product that trades on exchanges like stocks but has a face value and pays income like a bond. As the value of a preferred bond rises, its yield falls. Preferreds have performed well in the weeks leading up to the last four Fed rate-cut cycles, strategist Michael Youngworth said in an Aug. 6 note. Fixed-rate bonds with a face value of $25 have performed particularly well. Preferreds also have a face value of $1,000. “Preferred bonds posted the best average return on a cross-asset basis, trailing only the S&P 500, in the first cut,” he said. “While returns on risky assets typically decline in the weeks following the Fed’s first rate cut, preferred bonds still performed well relative to their peers, although they underperformed stocks after the first cut in September 2007.” [Global Financial Crisis] (hard landing) cycle.” The central bank’s next two-day meeting begins on September 17. Fed funds futures pricing data shows a 100% chance of a rate cut at that time, according to the CME’s FedWatch Tool. In July, Fed Chairman Jerome Powell said a September rate cut is “on the table.” Economists are expecting the central bank to deliver a soft landing. Solid earnings and favorable credit quality UBS also sees some attractive preferred securities right now. The firm’s list is based on those with favorable underlying credit quality, valuations and structures. “To minimize volatility in interest rates and spreads, we favor preferred securities that pay relatively high fixed rates,” UBS senior fixed income strategist Frank Sileo wrote in an August 7 note. Here are some of the fixed-rate names that have been cut. Remember that preferred securities typically have a call date, which is when the issuer can buy them back. These instruments also carry greater credit risk because investors in preferred securities are at the mercy of the bondholders if the issuer goes into trouble. Like many other fixed-income instruments, preferred bonds have had attractive returns. The ICE BofA Fixed Rate Preferred Securities Index, which tracks the performance of fixed-rate preferred securities, has a worst-case return of 5.86%. That’s higher than the 10-year average of 4.2%, said JR Humphreys, senior portfolio manager at Sheaff Brock Investment Advisors in Indianapolis. He noted that worst-case return—a measure of the minimum return an investor can expect to earn—is the best measure of preferred bonds. He’s bullish on preferred bonds, which he owns in funds he manages. Humphreys said that rate cuts will be a boost for these securities. In addition, he said, the largest issuers are financial institutions and insurance companies. “They have so much regulatory oversight that it adds a level of comfort.” Tackling the Preferred Bond Market Through ETFs For those looking to invest in preferred bonds, Humphreys recommends buying actively managed mutual funds or exchange-traded funds. “The preferred market is very inefficient,” he said. “It’s not like a stock where you can look at a set of parameters and get some kind of valuation. Each preferred issue may have different payouts and callable features.” Here are some preferred stock ETFs. If buying individual preferreds, it’s important to diversify across different issuers, Humphreys said. He also suggests buying discounted preferred securities on the secondary market. That’s because with interest rates expected to fall, the value of the securities will start to rise. “If interest rates fall, then [$25 par value] “Preferred bonds will go up a little bit and at some point they will go sideways, even if rates continue to fall,” he said. “It will be called at $25 one day.” If you buy a bond that is trading at $20, it could go up to $25 and continue to go up a few points, he said. “You will participate in the yield/price decline up to a larger amount,” he said. Richard Alt, chief executive officer of Carnegie Investment Counsel in Pepper Pike, Ohio, also rarely buys a new preferred issue because there are so many bonds trading at a discount. However, he buys them only for a handful of clients who need to boost their income. He noted that the assets are thinly traded and are not typically included in large funds. The downside to preferred bonds is that if the underlying company’s stock does well, the security will not participate in the upward trend. Plus, if a company goes bankrupt, bondholders have more of a claim to payment than preferred bondholders, Alt said. Investors should also be aware that the direction of interest rates and the economy affects the performance of preferred bonds, he said. You should be confident that interest rates will fall and that the economy won’t fall into a recession, he noted. If those boxes are checked, he thinks preferred stocks can be a good asset for investors looking to cut coupons. “If you don’t care about the stock price and the company is solid, you’ll probably be fine,” Alt said.