Invesco Variable Rate Preferred ETF (VRP): A Defensive Income Strategy in a Volatile Rate Environment

The Federal Reserve's aggressive rate hikes over the past two years have left investors scrambling to balance income generation with protection against rising interest rates. Amid this environment, the Invesco Variable Rate Preferred ETF (VRP) emerges as a compelling option for those seeking a defensive income play with reduced rate sensitivity. This article explores how VRP's unique exposure to floating-rate preferred securities and hybrid instruments, combined with its robust Morningstar rating and strategic rebalancing, positions it as a top-tier income vehicle in today's market.

Floating-Rate Exposure: A Shield Against Rising Rates

The cornerstone of VRP's strategy lies in its focus on floating-rate preferred securities and hybrid instruments—debt-like securities with coupon rates tied to short-term benchmarks (e.g., SOFR or LIBOR). Unlike fixed-rate preferred stocks, which decline in value when rates rise, floating-rate securities adjust their coupons periodically, mitigating interest rate risk. This structural advantage is critical as the U.S. Treasury yield curve remains elevated, with the 10-year Treasury yield hovering near 4.0%—a level unseen in decades.

VRP's portfolio is designed to capitalize on this dynamic. By targeting securities with variable rates, the ETF reduces its duration risk, making it less vulnerable to sudden rate spikes. This feature is particularly advantageous as the Fed pauses its tightening cycle but keeps rates high to combat inflation.

Morningstar's 5-Star Validation: A Track Record of Resilience

As of December 31, 2024, VRP maintained a 5-star Morningstar rating across three-, five-, and ten-year periods, outperforming 90% of its peers in the Preferred Stock Category. The rating reflects the fund's ability to deliver risk-adjusted returns, even during periods of market stress. For instance, during the 2022 rate-hike cycle, VRP's NAV fell less sharply than its fixed-rate peers, showcasing its defensive characteristics.

However, investors should note that Morningstar ratings are updated periodically. While VRP's strong track record suggests it may retain its 5-star status in Q2 2025, the most recent rating data should be confirmed via Morningstar's official platform.

Diversified Sector Allocation: Broadening the Safety Net

VRP's portfolio is thoughtfully diversified across sectors, reducing reliance on any single industry's credit risk. As of its latest filing, the top allocations included financials (35%), utilities (25%), and energy (15%)—sectors with historically stable cash flows and robust dividend policies. This diversification not only mitigates concentration risk but also ensures exposure to industries that typically perform well during inflationary environments.

The fund's monthly rebalancing process further enhances its adaptability. Unlike static ETFs, VRP adjusts its holdings to reflect changes in the ICE Variable Rate Preferred & Hybrid Securities Index, ensuring it stays aligned with evolving market conditions. This active recalibration helps capture opportunities in sectors or issuers that become more attractive as rates stabilize.

Timing the Fed's Pause: Why Now Is the Moment for VRP

With the Fed's rate-hike cycle likely concluded and short-term rates expected to remain elevated for the foreseeable future, VRP's floating-rate focus becomes a double-edged sword:
1. Income Stability: Variable coupons will reset higher as rates stay elevated, boosting distributions.
2. Capital Preservation: The lack of prolonged rate hikes reduces the risk of principal erosion tied to rising yields.

In prior Fed pauses (e.g., 2018–2019), VRP outperformed its fixed-rate peers by an average of 2.5% annually, as its floating coupons insulated it from yield curve volatility. Today's environment mirrors that scenario, with the Fed signaling no further hikes unless inflation surges unexpectedly.

Risks and Considerations

While VRP's strategy is compelling, it is not without risks:
- Credit Risk: Preferred securities rank below senior debt in the capital structure, exposing investors to issuer-specific defaults.
- Liquidity: Hybrid instruments may trade less frequently, potentially widening bid-ask spreads during stress.
- Index Tracking: VRP uses a “sampling” methodology to replicate its benchmark, which could lead to performance divergence.

Investors should also monitor the ICE Variable Rate Preferred & Hybrid Securities Index's composition and any shifts in its risk profile.

Investment Takeaways

For income-focused investors seeking to navigate a high-rate environment, VRP offers a compelling blend of yield, defensive characteristics, and diversification. Key takeaways:
- Yield Potential: VRP's trailing 12-month yield of 5.2% (as of May 2025) rivals high-yield bonds while offering lower credit risk.
- Rate Resilience: Its floating-rate exposure reduces duration risk, making it a safer bet as rates plateau.
- Strategic Rebalancing: Monthly adjustments ensure the portfolio stays optimized for changing rate dynamics.

Final Recommendation

Invesco Variable Rate Preferred ETF (VRP) is a buy for income investors prioritizing rate sensitivity and diversification. While investors should confirm its latest Morningstar rating for Q2 2025, its historical performance and structural advantages suggest it remains a top-tier income vehicle. Pair VRP with short-duration bonds or dividend-paying equities to further hedge against inflation and volatility.

As the market shifts from rate hikes to normalization, VRP's unique exposure to floating-rate securities positions it to deliver steady income without sacrificing principal safety—a rare combination in today's landscape.

Data as of May 31, 2025. Past performance does not guarantee future results. Always consult a financial advisor before making investment decisions.