Call Risk
Investors ignore the yield to worst at their peril, said Andrei Costas, a senior investment analyst at STA Wealth Management LLC, which sold its holdings in the ETF in February.
“Changing the yield to worst can change the return profile. It factors into an investor’s decision whether to buy or sell a fund,” Costas said. For the PowerShares Preferred Portfolio, the yield to worst is less than a third of the distribution yield.
James Meyers, director of fixed income at PowerShares, said in an interview by telephone, “We think some other yield calculations are more important,” including yield to maturity and distribution yield.
Bank of America’s changing methodology reflects the fact that many of the securities in the index could have negative yields if companies call them. After interest rates fell post crisis, the value of many preferred shares jumped above face value and may still remain there—the securities in the index trade on average at around 105 cents on the dollar, according to Bank of America Merrill Lynch index data. If the securities were now bought back for 100 cents on the dollar, investors could suffer losses that make the yields to worst negative.
Last month, Bank of America Merrill Lynch started accounting for the fact that some preferred shares had negative yields to worst. Before, the bank ignored any such measures that were negative for individual securities, and used a different yield measure for those securities instead when determining the index’s overall yield to worst.
The PowerShares Preferred Portfolio is the second-biggest ETF focusing on preferreds, behind the iShares U.S. Preferred Stock ETF (PFF), which has around $17.5 billion of assets.
This article was provided by Bloomberg News.