Navigating the Hidden Dangers of Negative Yield to Call in Preferred Securities: A Strategic Guide for Income-Seeking Investors

In a world where traditional fixed-income yields remain stubbornly low, preferred securities have emerged as a tempting alternative for income-focused investors. These hybrid instruments, blending traits of bonds and stocks, often offer yields exceeding 6.5%—a stark contrast to the paltry returns of U.S. Treasuries or investment-grade corporate bonds. However, beneath their alluring surface lies a critical risk: negative yield to call (YTC). This structural vulnerability can turn high-yield promises into capital losses, creating a dangerous misalignment between risk and reward.

The Paradox of Preferred Securities

Preferred securities are designed to provide steady income, typically with fixed dividends and a par value (often $25). Yet their callable nature introduces a unique hazard. When interest rates decline or issuers seek to refinance at lower rates, they may redeem these securities early—often at par. If an investor purchased the security at a premium to par, the redemption locks in a capital loss, resulting in a negative total return. For example, a preferred security bought at $30 and called at $25 yields a 16.7% loss, despite its 7% dividend.

This risk is amplified in 2025, as the Federal Reserve's anticipated rate cuts and the "One, Big, Beautiful Bill Act" drive fiscal uncertainty. With the 10-year Treasury yield at 4.23% and spreads tightening to 73 bps, issuers are increasingly incentivized to call high-cost debt. The result? A surge in negative YTC scenarios for investors who overlook this metric.

Why Negative YTC Signals a Risk-Reward Imbalance

The allure of preferred securities lies in their high yields, but this comes at a cost. Unlike bonds, which typically mature at par, preferreds can be called at any time after a set date. This creates a duration mismatch: investors may lock in a high yield for only a fraction of the security's stated maturity. In a low-yield environment, this imbalance becomes critical.

Consider a preferred security with a 7% coupon, a 2035 maturity, and a 2026 call date. If purchased at $30 in 2024, its yield to call is a mere 2.3%, far below its current yield. If the issuer calls it in 2026, the investor's total return becomes negative. This scenario underscores how high yields can mask hidden risks, particularly in a market where rate cuts are expected to drive early redemptions.

Strategic Navigation: Tools for Savvy Investors

To exploit the risk-reward dynamics of preferred securities, investors must adopt a proactive approach:

1. Leverage Actively Managed ETFs
   Passively managed funds like PFF (the iShares Preferred & Income Securities ETF) often include securities with negative YTC features. In contrast, actively managed ETFs such as Principal Spectrum Preferred Securities Active ETF (PREF) and Virtus InfraCap U.S. Preferred Stock ETF (PFFA) screen out these risks. These funds prioritize preferreds with favorable call dates, cumulative dividends, and strong credit ratings, offering a more balanced risk-return profile.

2. Analyze Yield-to-Call Metrics
   Investors should evaluate not just current yield but also yield to call. A security with a current yield of 7% but a negative YTC is a red flag. Use tools like the Schwab Preferred Stock Screener to filter for securities with call dates beyond 2027 and yields to call above 4%.

3. Diversify Across Sectors and Credit Qualities
   Preferred securities are concentrated in financials and real estate, sectors prone to volatility. Diversifying into higher-credit-quality issues (e.g., A-rated or above) reduces the risk of default or deferral.

4. Monitor Interest Rate Trends
   The Federal Reserve's policy path is pivotal. If rate cuts materialize in 2025, as currently priced in futures markets, the likelihood of early calls will rise. Investors should adjust their portfolios accordingly, favoring securities with longer call protection periods.

The Tax Advantage: A Double-Edged Sword

Preferred securities offer a unique tax benefit: qualified dividends are taxed at lower rates than ordinary income. This makes them particularly attractive in high-tax environments. However, this advantage is negated if the security is called at a loss. Investors must weigh the tax benefits against the risk of capital erosion.

Conclusion: Balancing Income and Resilience

Negative yield to call is not just a technicality—it's a structural risk that can undermine the very purpose of income investing. In a low-yield world, preferred securities remain a compelling option, but only for those who understand their nuances. By prioritizing actively managed funds, scrutinizing call features, and aligning holdings with macroeconomic trends, investors can transform this risk into a strategic advantage.

As the market evolves in 2025, the key to portfolio resilience lies in selectivity and vigilance. Preferred securities, when navigated wisely, can enhance income potential without sacrificing capital preservation. The challenge is to avoid the trap of chasing yield at the expense of longevity.