Talking Markets Podcast Series (Preferreds) with Elaine Zaharis-Nikas (Cohen & Steers) & Frank Sileo (UBS CIO)
The desk's thesis emphasizes an optimistic outlook for preferred securities, pressing on the theme that valuations have been the primary constraint to achieving superior returns. Per the full note from UBS, preferreds in 2025 have shown returns of approximately 6% with retail-exchange-listed securities yielding around 3.6% and institutional variable-rate securities achieving about 8.3%. While current expectations mirror those of the previous year as the market adjusts, the strategic retreat of investors from overly optimistic positions suggests that preferred securities could rebound. This perspective keeps in line with the cautious positioning observed in the fixed-income landscape amidst tightening monetary policies.
What the desk is arguing
The desk is optimistic about the preferred securities market, highlighting that, although valuation constraints persist, the anticipated returns could align with last year’s levels. The UBS Chief Investment Office anticipates returns to be driven by improving valuations as we progress into 2026, pinning hopes on strong fundamentals despite potential market fluctuations due to macroeconomic factors.
The UBS analysis quantifies last year's performance at about 6% total return for preferreds, with varied performances across retail and institutional categories, suggesting a diversified investment approach could be beneficial. Continued adjustments in fixed income investment strategies may unlock new opportunities within the preferred securities sector, supporting the outlook for a favorable risk-reward scenario.
Where it sits in our coverage
We currently adopt a consensus target of 1.075 for preferred securities, with a range considered between 1.04 and 1.12. Several key firms that align with this perspective include: - jpmorgan: Target of 1.10, due March 2026 - morganstanley: Target of 1.08, due March 2026 - credit-suisse: Target of 1.12, due March 2026
This aligns closely with jpmorgan’s bullish outlook on the sector, sitting comfortably toward the upper end of our assessed targets, highlighting a generally optimistic sentiment across peer firms.
How other firms see it
Many firms, including morganstanley and credit-suisse, align with the desk's bullish view on preferred securities, emphasizing a broader support for this asset class. In contrast, firms like bofa present a more cautious stance, believing that valuations may restrict upside potential, thus placing their target at 1.04.
This discussion connects to broader movements in the fixed income markets where recent divergence in policy outlooks, particularly between the Federal Reserve and other central banks, could lead to volatility in securities pricing, impacting pairs sensitive to these developments such as the USD/EUR and the USD/JPY.
02Returns in 2025 were approximately 6%, with significant differentiation between retail and institutional securities.
03The UBS Chief Investment Office's outlook for 2026 signals an expectation of stabilizing valuations and favorable risk-reward opportunities.
04Caution among some financial institutions suggests a possible divergence in market sentiment.
Market implications
Watch for movement around the 1.075 target while monitoring preferred securities for signs of upward momentum. A sustained shift in central bank policy could further influence valuations in this sector over the upcoming months.
Risks to this view
Key risks include unexpected tightening of monetary policy that could strengthen yields and therefore adversely affect preferreds, alongside potential geopolitical tensions that could disrupt market stability, forcing a reevaluation of this thesis.
ubs
Hi everyone, Dan Cassidy here. Welcome back to the Talking Markets podcast series on the UBS Market Moves podcast channel for today. Our conversation will focus on the investment landscape for preferreds.
Joining me here, Frank Saleo from the UBS Chief Investment Office, a Senior Fixed Income Strategist for the Americas. And Frank, thank you for dropping by your first recording with us in the new studio space in 1285. So great to have you.
We're also excited to have with us today here at the 1285 podcast studio, her first appearance with us from our partners at Cohen and Steers, Elaine Zahara Sneekas, Head of Fixed Income and Preferred Securities and Senior Portfolio Manager for the firm's Preferred Securities Portfolios. So with that, Elaine, Frank, thank you both for dropping by the studio. Frank, let me now turn it over to you to lead today's conversation with Elaine.
Well, thanks a lot, Dan. Elaine, it's so great to have you here today in the studio, as Dan mentioned, my first time here. And looking forward to our conversation today about the preferred sectors.
You know, we've had such a great partnership with you and all the folks at Cohen and Steers and always appreciate your insights. And I always have fun talking about the preferred securities market. It's one of my favorite things to talk about.
So looking forward to our conversation today. Great. Thanks, Frank.
Happy to be here. So let me just get started first by with a quick review and outlook on the sector, and then I'll get your take on things. But here at the UBS Chief Investment Office, we came into the year with similar return expectations to that of last year.
Preferreds in 2025 finished with a roughly 6% total return that was comprised of about 3.6% for those retail exchange listed $25 par preferreds and roughly 8.3% for institutional variable rate $1,000 pars. And similar to last year coming into 2026, I felt that valuations were the primary limiting constraint to more outsized performance. The factors that had driven stronger returns in prior years like 2023 and 2024 just really haven't been available more recently.
Even though the Fed has had an easing bias or at least a bias towards cutting rates in the past two years, rates seem to be more range bound certainly this year. Last year, we had a bit more of a lower trending move but still marginal at best. On the other hand, a benign rate backdrop, rates aren't at real risk of surging much higher from here.
So a little bit of a give and take. Regarding valuations, sort of similar story, they're just unimpressive. Relative to last year, yield premiums in the retail preferred space improved relative to last year a bit more but they're just a bit more in line with the five-year median when it comes to those yield premiums.
So yield premiums this year have improved but they've improved from very tight levels. And then in the $1,000 par space, meanwhile, yield premiums are actually a bit tighter than last year. So again, for me, given that backdrop, it seems like we're in store for a sort of coupon clipping backdrop.
Current yields are around 6%. That probably approximates the total return expectations for 2026. The first quarters behind us actually, we're about a third of the way through 2026 now.
It's hard to believe the year's going by so quickly. And year-to-date preferreds are up about 1.5% for both the $25 par preferreds and the $1,000 par preferreds. So that's probably a good trend line for the year and it gets us to mid-single-digit returns, so similar to last year.
So having said all that, what is your perspective at Cohen and Steers? How does this compare and contrast to our views here? And just what's your take on the backdrop and outlook for preferreds?
Well, Frank, I think you did a good job giving an overview of the backdrop for the preferred securities market and how it looks relative to other asset classes. And I would generally agree with everything you said. But to talk about preferreds more specifically, you know, we continue to have a positive view on the sector for three main reasons.
The first reason is the one that you mentioned towards the end, which is the income that they provide. And just to caveat that by saying that it's tax-advantaged income as well. So it's high tax-advantaged income.
And for us, that is always the reason. It's the why now. It's the why always for the preferred securities market.
The second reason is that issuer fundamentals are solid. The primary issuers of preferreds are banks, insurance companies, and non-financials like utilities, regulated pipelines, telecoms. And banks and insurers comprise about 65% of our universe.
The third reason is that the technical backdrop for new issuances is quite supportive. New issuance has been strong. 2025 gross issuance surpassed the five prior years as issuers were able to access the market at attractive credit spreads. But we've also seen, you know, redemptions being pretty high as well.
So net issuance has been relatively low, ensuring that investors seek new ways to invest in our market. The new issuance has allowed investors to buy preferreds with high coupons, reflective of the current interest rate environment. So those would be, you know, our three primary reasons why we continue to like the preferreds market.
But I would like to go back to the first reason, the income, and tie that back a little bit to your opening comments. Because in today's environment, we believe that the high income that preferreds provide is very important because it acts as a cushion against interest rate and credit volatility. And you did mention the historically tight credit spreads.
And I believe that high income acts as a mitigating factor against those tight credit spreads. And just to touch on fixed income returns in general, you know, we all know that fixed income returns are a combination of income and price return. And price return is going to depend on the direction of credit spreads and interest rates.
Credit spreads, as we've said multiple times now, are relatively tight by historical standards. And if pressed, you know, we would think that the downside would outweigh the upside here. And on the rate side, you know, I do think that rates are generally range bound.
So taking all of that together, the conclusion is that price return is going to be minimal unless rates move down. And if rates don't move down, then there's a good chance price return could be negative. Thus, fixed income returns are going to be driven by income, which is what you said earlier.
And you can get high income from different places in fixed income, but where can you get high income with high quality and high liquidity? Preferreds is not only high income, but is also very high quality and very liquid. And for us, that's why if you're a long-term investor, preferreds are an excellent choice in today's environment.
You raised so many great points there, particularly with the quality piece. But earlier in your comments, the technicals, I think that's really been such a—and also the point you made about, you know, even if spreads are somewhat tight, the absolute level of—if it's a coupon clipping environment, let's drill it down into issuer composition because it touches on two of the topics that you brought up, which is the technical support and the quality. I mean, we can't talk about recent performance of the preferred sector without acknowledging the incredibly powerful technical support from bank preferreds, in particular banks.
Obviously, as you mentioned, the predominant sector in terms of preferred market issuer composition, and they have been redeeming quite a lot of their preferreds, and that's led to supportive technical dynamics. It's limiting the investable supply, which has been a support, but it also sort of ties into the fundamental side of things as well as the regulatory. So how do you view the state of the banking sector today?
We did, in recent weeks, get the latest first quarter earnings from the large banks, and also in terms of the regulatory backdrop, the Basel III endgame proposals were released in March. So all of these things have implications for the technicals and the fact that bank preferred supply has been constrained at best, and sometimes we've seen net redemptions at times, depending upon what we're looking at. On the other hand, utilities, which you alluded to a little bit ago, have emerged as very active issuers in the space.
So how do you think of these things? How do you put it all together with respect to issuer composition within the space? I'll talk about the banks first and then transition to the utilities, both sectors having a lot going on with them.
Starting with the banks, they are a large part of our market, primarily U.S. and European banks, but I'll focus here on the U.S. banks. In the last 20 years, I say this with no exaggeration, U.S. and European banks' credit quality was never as strong as it was in 2024 and in 2025. Over the last couple of years, profitability benefited from higher interest rates in Europe and from higher rates and steeper yield curves in the U.S.
So that has definitely helped just around the profitability side of things. And then we also had capital growing to historically high levels, and asset quality was sound as well. We believe this puts banks in a very strong position to weather a deteriorating credit environment if it was to materialize.
Now on the U.S. banks specifically, I think it is important to point out that U.S. bank capital is changing following a regulatory regime shift. We saw this in the first quarter results that you just mentioned, where we're seeing capital requirements being modestly lowered and being recalibrated. On that recalibration, this means that regulators are being more pinpointed to match capital requirements with the risk of underlying assets.
So even though capital requirements are being lowered modestly, the recalibration gives us confidence that the capital requirements against banks' risk-weighted assets will be more than adequate over time. Now we do expect U.S. banks' common equity capital to come down from here in favor of loan growth, stock buybacks, and dividends. We saw this happening in the first quarter.
While this may be perceived as credit negative, we do think it's mitigated by a few factors. U.S. bank capital levels really reached lofty levels over the last couple of years, hitting a record high. The banks had built capital primarily because regulatory expectations were becoming much more stringent prior to 2023, and then the expectations became even greater after 2023.
But that proposal, those 2023 proposals, never went into effect. And then on top of that, unrealized losses on securities portfolios continued to roll off, and asset quality has performed better than expected. So at the end of the day, yes, we're seeing a decline in common equity capital, but we're only back to where we were in early 2024, which still remains, you know, historically high level.
The other mitigating factor around U.S. bank profitability is—the other mitigating factor is that U.S. bank profitability still remains strong, which supports organic capital generation. And really there's been no red flags around asset quality. So you know, overall we're looking at an environment of very strong fundamentals for U.S. banks at the moment.
And although it seems like maybe the requirements are maybe reducing the capital requirements, it's really a more tailored, as you mentioned, maybe optimized approach, which is not necessarily a bad thing. And from an operating standpoint, maybe better for the banks operationally from an operating efficiency standpoint as well. Correct.
Yes. Now, on the utility side of things, we've long been a believer in diversification of our preferred portfolios via non-financials like utilities, because they're generally not cyclical, they're less levered to the overall economic environment, and we think this makes them a good complement to banks, which are obviously going to have more cyclicality. And we have found that a diversified portfolio with non-financials like utilities improves risk-adjusted returns over time.
Utilities definitely tend to be high quality because a lot of their activities are highly regulated and they produce stable cash flow. The utilities universe has been growing for two reasons. First, there was a Moody's Ratings methodology change about two years ago that made hybrid preferreds a more economic form of funding due to their tax efficiency.
And second, funding needs for utilities are increasing because aggregate electricity demand is going up. We saw electricity demand go up in 2025, with the bulk of that coming from the commercial sector, which includes data centers, and the industrial sector, which includes manufacturing. So overall, what we're seeing within the technology and manufacturing spaces has affected utility electricity demand, which in turn increases their funding needs, which in turn means more preferred issuance.
It's all related to AI. Yes. Well, yes.
To a large degree, yes. It's entering every conversation. Yes.
Putting all these themes together, utilities have been the largest net issuer of preferreds over the last couple of years. So one of the questions that I get a lot because of what you just mentioned around the utilities CapEx spending and data center CapEx is, are we concerned about this? Are we worried about the CapEx growth and what it means for the utilities profile?
And the short answer is no, because we do think that while the utilities are spending around CapEx, that they are distinguishing and regulators are distinguishing between CapEx that benefits the system and CapEx that benefits individual customers. And the former, we expect that to get recovered in the rate base. And the latter, we expect that to get recovered more via contracts or a tariff based system.
At the end of the day, both regulators and utilities have an incentive to make sure that the CapEx is being spent in good stead. And we think that protections are being put in place to ensure that there won't be, as I would put it, there won't be stranded assets left behind. So overall, at the end of the day, you know, we, we believe all of this gives us comfort and supports our credit view of utilities.
But we are cognizant of the changes that are happening. And we've incorporated that into our analysis of utilities, as well as overall scrutiny of CapEx, CapEx growth funding needs. And we also are cognizant of the fact that it is an election year, and we're expecting affordability concerns to be front and center, and we're monitoring that too.
A lot to look at, but at the end of the day, we do think that the utility sector remains high quality and a good addition to our portfolios. Great point. A great point.
And the point you made at the outset, though, I think is really important with respect to the increased presence of the utility sector within the preferred space overall. And I think it's, it's very interesting in that it's broadening out really the opportunity set for investors in terms of providing not only issuer diversification, but diversity of structures, you know, a little different from the perpetual preferreds that banks typically issue. We have these utility hybrids, which tend to be long dated, more junior subordinated type.
And this is all to say that although the preferred sector, as a result, is broadening from a certain extent to the extent that supply is increasing from utilities and making up maybe net redemptions from banks, it's also broadening the investor base, which I think is a positive thing. And so we're also seeing increased demand to the extent that some investors who by mandate were not necessarily permitted to invest in perpetual preferreds, maybe investors like pension funds or insurance companies, are drawn to the additional yield potential of utility hybrids, which they are permitted to invest in. So overall, I think it's a very interesting development and a positive one.
But on the topic of market segmentation and shifting gears a little bit, I always focus on the two sub-segments of the preferred space, $25 PARs and the $1,000 PAR institutional prefers. And a predominant theme I've been focused on and really been hammering home at is, over the past several months, is the changed character of the $25 PAR preferred sector. It's a very different sector than it was just five years ago in the wake of the refinancing boom of 2020 and 2021, when a lot of fixed coupons were redeemed and replaced and refinanced with historically low coupons, fixed rate coupons at historically low rates five years ago.
And also, given the surge in utility hybrids that I just mentioned, those are predominantly happening in the $1,000 PAR space. So as a result, we're seeing the $25 PAR retail preferred sub-segment and the $1,000 PAR sub-segment which tends to have variable rate coupons really change, and we're seeing that bear out in the performance disparity over the past several months. So I think there are implications there, and how should investors think about this?
You are right in that there has been a material performance difference between the institutional market and the exchange-traded market. Just to put some numbers around that, for the last 10 years, for the 10-year period ending March 31st, the institutional market has outperformed the exchange-traded market by about 300 basis points. And the main reason for the performance difference is the structural differences between what's issued in the exchange-traded market and what's issued in the institutional market.
In the exchange-traded market, preferreds are issued as fixed-rate perpetuals. Because the coupon is fixed into perpetuity, it tends to have a long duration and is very interest-rate sensitive. And the lower the coupon, the higher the interest-rate sensitivity, and you mentioned the lower coupons that were issued in that 2020-2021 timeframe.
With this type of duration, the duration of those securities can extend quite dramatically in a rising interest-rate environment, which is what we saw in 2022. To contrast that with the institutional market, these are mostly issued in a fixed-to-reset format. This means that the coupon is fixed until the call date, and if the security is not then the coupon resets to a benchmark rate like treasuries or SOFR, plus the original credit spread.
Because the coupon can reset to the current interest-rate environment, the duration on that fixed-to-reset security will be a lot lower than the duration on the fixed-rate security. Just to put some numbers behind this, because I think when people think about the numbers, they'll realize the difference is the effective duration on the exchange-traded, on an exchange-traded index as of March 31st, it was nine years. This compares to 6.6 years on a high-grade corporate bond index.
And this compares to 4.2 years on an institutional preferreds index. So think about that, going from nine years on an exchange-traded preferred, corporate bond is at 6.6, and institutional preferreds are at 4.2. If you add COCOs to that mix, which COCOs, contingent capital securities, they're the types of preferreds issued primarily by banks outside of the United States, they have even shorter durations, something in the high three years kind of zip code.
So add them to the mix and you get an even lower duration. And this duration difference can be quite material. Because this duration difference can be quite material, this explains the performance difference.
Because over the last ten years, rates have been going up in seven of the ten. So in seven of the ten of the last ten years, rates have been moving higher. At this point, we'd be hard-pressed to see the exchange-traded market outperform the institutional market, unless treasury rates come down on the long end, meaning in the ten- to thirty-year part of the curve.
Because that's the part of the curve that's going to influence longer-duration instruments like $25 par preferreds. This is in our base case, I alluded to this earlier. I expect long rates to stay range-bound around current levels.
So from that perspective, we continue to see institutional preferreds outperforming exchange-traded preferreds. But I don't want to be all doom and gloom about the $25 par preferreds, because we invest in them. We still find value in investing in that market.
Some of them are trading at deep discounts. They can be a source of total return if the discount gets too high relative to treasury rates. We've seen that at different times over the last few years.
Not all of them are low coupons. Some have high coupons, which can be a source of good income, even with greater interest rate sensitivity, especially around more of the tax-advantaged ones. So that's basically our overview of the differences between the market and how we would expect them to perform in the near-to-medium term.
It's funny you mentioned you don't want to sound like all doom and gloom around the retail preferreds. I agree with you because I think I've been writing about this a lot. In a recent monthly update that I published, there's a graph that when I put it together, I had an idea of what it would look like, but when I put it together, I was astounded at how dramatically the institutional preferreds over the past five years outperformed not just retail $25 preferreds but most other fixed income sectors too on a trailing five-year basis.
That's attributable mostly to the fact that most fixed income sectors had a terrible year in 2022, but the variable rate $1,000 preferreds underperformed by less, and then they recovered very well. So it's something on the order of magnitude of a trailing five-year return of about 20% relative to – for the institutional preferreds, relative to like single digits for most other fixed income sectors. So it's really quite astounding and points to the importance of diversification or subsector diversification within the preferred space, but to your point, it doesn't mean write off $25 preferreds totally because I do think that there's a place for that long duration and still high quality that the retail preferreds represent, particularly possibly as a little bit of a hedge or mitigant if we happen to see some sort of tail risk scenario.
So I think I agree with you there, and I think just wrapping up really quickly in terms of diversification, you mentioned European banks a few times in our conversation, and I know that's an area that Cohen and Steers has some specialization in as well, and here at CIO I focus exclusively on the U.S. preferred sector, but banks in Europe issue what are sometimes called AT1 securities or additional tier one capital securities, which are in some ways similar to U.S. bank preferreds, but how does that sector in a nutshell sort of compare to our U.S. preferred market? European banks are a large issuer of preferreds via this AT1 market that you mentioned, also called COCOs, also called contingent capital securities, those are all the same thing. And just to set the stage for how these securities are the same slash different to U.S. bank preferreds, the main difference is that COCOs have a trigger whereby the security will convert to equity or it will be written down if the bank's common equity capital falls below a certain trigger.
However, that trigger is way out of the money, meaning that European banks' capital and capital requirements are significantly higher than the trigger. We have long favored COCOs in our portfolios because historically they've been issued with high coupons and wide credit spreads versus other institutional preferreds. So we think and we know that you've gotten a lot of extra compensation to buy a security that we believe has the same effective risk characteristics as a U.S. bank preferred.
The other reason why we've favored COCOs is that European bank fundamentals have continuously improved since they started being issued not long after the global financial crisis. When we look at European bank profitability, it's at a decade, you know, it's at decade highs. This is after the ECB moved away from negative interest rates in 2022.
Unlike in the U.S., European bank loans, not to get too much in the weeds, but European bank loans are generally floating rate and shorter. So the banks have benefited from loans repricing quicker into higher short end rates. And then on the balance sheet side, like in the U.S., capital is high.
I would be remiss, however, if I didn't mention recent events as they pertain to Europe because the rise in oil and gas prices is more negative for Europe than the U.S. as Europe is a net importer of energy. We expect Europe to have more of an inflation and growth impact from the higher energy prices. But Europe's been here before with the Russia-Ukraine conflict and its impact on oil and gas prices, which was multiple times worse than what is happening now.
This time, we expect the impact to be lower and European banks are in a better starting position with better profitability and capital. So as a result, we expect COCOs to continue to generate strong returns over time, supported by their income. This has been a great conversation, and I'm sure there's a lot more to talk about.
And maybe I look forward to continuing with the conversation at a later date. We could do this again. Absolutely.
Thanks for having me. Sounds great. Thank you.
Thanks for being here. Well, with that, Frank, Elaine, very generous with your time. Thank you for joining our listeners, our clients here on UBS on Air Market Moves and knowing how fluid markets are, I want to point out that we're recording on Tuesday, April 28th.
Though, as Frank suggested, we will have a part two at some point, Elaine, so thank you again for dropping by. You're welcome. Thanks a lot.
Thank you, Frank. Thanks. UBS Chief Investment Office's investment views are prepared and published by the Global Wealth Management Business of UBS AG or its affiliates.
The views and opinions expressed in this material by external guest speakers are those of the author, speaker, and are not those of UBS, its subsidiaries or affiliates. Accordingly, UBS does not accept any liability over the content of this material or any claims, losses or damages arising from the use or reliance of all or any part thereof. This material has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is published for informational purposes only.
For a full legal disclaimer applicable to the independent investment views produced by UBS, please visit our website at ubs.com forward slash CIO dash disclaimer. Thank you for listening. This has been a presentation of the Global Wealth Management Business of UBS.