While most fixed-income strategies face the prospect of declining yields as the Federal Reserve cuts rates, consider an ETF that demonstrates the potential for rising income over time. The Principal Spectrum Preferred Securities Active ETF (ticker: PREF) has grown from $25 million at launch to $1.2 billion today, making it the most rapidly growing strategy in Spectrum Asset Management’s $19 billion book of business.1 Spectrum is an investment team within Principal Asset Management.
James Hodapp, Senior Vice President and Portfolio Specialist at Spectrum, is part of a team that oversees a strategy built around a compelling structural advantage that addresses a key challenge facing income-focused portfolios: maintaining and potentially increasing yield even as interest rates decline. Behind the impressive asset growth for PREF lies a unique approach to preferred securities that few investors fully understand—and even fewer can access through traditional investment vehicles.
The Fixed-to-Float Advantage Creates Rising Income Potential
This strategy’s fundamental appeal centers on its exclusive focus on $1,000 par institutional preferred securities with reset features. Unlike traditional fixed-rate preferreds, every security in the portfolio carries either a floating-rate structure or a fixed-to-reset coupon mechanism.
“What’s really interesting with these securities of that fixed-to-refixed feature that are in PREF, nearly 100% of the portfolio has a floating or reset coupon,” explains Hodapp in an interview with The Wealth Advisor. “Think about those 4% coupons that came to market in 2021, refinancing 5s, 6s, and 7s. Well, those 4s that were issued in 2021—in 2026 will either get called away at par or reset to 6%, 7%, some of them 8% plus coupons.”
The mechanics create a powerful dynamic for investors, generating strong potential for income growth regardless of interest rate direction. Securities issued during the low-rate environment of 2020–2021 typically include provisions requiring issuers to either call the security at par or reset the coupon to current market rates after five years. With the Federal Reserve maintaining higher rates and Treasury yields significantly elevated from their 2021 lows, many securities are positioned for substantial coupon increases.
“If rates move higher, your coupon is likely to rise, but even as short rates come down towards the Fed’s target at 3%, your rates are likely to continue to move higher,” Hodapp notes.
The PREF average coupon has already demonstrated the power of the structure, rising from 4.9% in late 2023 to 5.2% by year-end 2024, and reaching 5.5% as of July. Looking ahead, approximately 60% of the portfolio faces either coupon resets or potential calls in 2025, 2026, or 2027. The refinancing dynamics can create favorable scenarios for PREF holders, as issuers typically call away low-coupon securities and refinance at prevailing market rates.
“Those issuers are likely to refinance somewhere in the mid-6s, so your 4% and 5% will get taken out, and then we’ll be reinvesting that money, likely in the mid-6s, bringing rising income to clients even as short-term interest rates come down, which will prove to be quite powerful,” Hodapp explains.
Active Management Navigates Complex Credit and Structure Decisions
The preferred securities market presents unique challenges that passive strategies cannot address effectively. Within a single major issuer, investors might find approximately 50 different preferred securities with varying structures, terms, and features.
“Some were fixed rates, some were floating, some had a fixed variable or fixed-to-refixed coupon. Some were $25, some were $1,000 par,” Hodapp explains. “So, [major money center banks] represent credits that we like. But you have to then decide what structure do you want to own.”
The 28-person Spectrum team, based in Stamford, Connecticut, focuses exclusively on preferred securities analysis and management. Unlike competitors who manage preferreds as a secondary asset class, the team conducts no equity, municipal bond, or high-yield bond management.
The approach emphasizes credit quality, with every security purchase requiring the issuer’s senior debt to carry an investment-grade rating. While the preferred securities themselves may carry lower ratings because of their subordinated nature, the underlying credit strength provides a foundation for the income strategy.
Active management proved particularly valuable during the 2023 U.S. banking crisis, when the team moved out of 16 regional bank positions. Currently, the portfolio holds no securities where the management team feels uncomfortable with credit quality, an unusual position that reflects selective security analysis. The complexity of the preferred securities market makes active management essential rather than optional.
“Active management can make an enormous difference,” Hodapp emphasizes. “The preferred securities market is not a commoditized asset class. Each credit’s different, each structure is different, and certainly clients and advisors should be using active strategies such as PREF.”
Market Structure Favors Institutional Securities over Retail Issues
The PREF strategy’s exclusive focus on $1,000 par institutional securities provides access to a growing segment while avoiding limitations found in the retail $25 par market. “The market is continuing to grow on those institutional $1,000 par securities that are what we own in PREF,” says Hodapp. “The $25 retail market has continued to shrink as more and more issuers have called away their $25 pars and refinanced by issuing the $1,000 pars that have that fixed-effects feature.”
The structural difference creates meaningful implications for investors, particularly around income predictability and growth potential. In the retail market, approximately 90% of listed $25 par securities carry coupons fixed for life, limiting upside potential as rates change. PREF excludes such securities entirely, focusing instead on the reset structures that can benefit from rate environment changes.
The pricing differential between similar securities with different structures illustrates the advantage of active selection. Securities with identical issuers and coupons can trade at vastly different prices based solely on their reset provisions.
“It’s hard to believe you could have two issues of the same issuer and both with the same coupon, 4% in this example, and one of them, the fixed-rate security, is going to be trading in the mid-60s and the one with the five-year reset that came in 2021 and ’26, it gets called away,” Hodapp observes. “Your reset is trading up near par.”
Sector Allocation Emphasizes Regulated Entities
Sector allocation in the strategy reflects the broader preferred securities market’s composition while emphasizing regulated entities that provide stability for income-focused strategies. The regulatory oversight creates a more predictable operating environment and constrains excessive risk-taking that could jeopardize dividend payments. Approximately 90% of holdings consist of banks, insurance companies, and utilities—all heavily regulated industries.
“You don’t often hear money managers saying they like regulation, but we own no common stock, so we’re looking to bring you high-quality income,” Hodapp explains. “So, the regulation keeps these companies from leveraging their balance sheets too much, which could benefit the shareholder, but that would not benefit us—the fixed-income holder, the preferred holder.”
Banks represent roughly 60% of the market, including money center banks, brokerage firms, and credit card companies.
Insurance and reinsurance companies comprise about 20% of the market, while utilities represent approximately 10% and growing. The utility sector growth reflects increasing power demands from data centers and infrastructure needs.
Two areas show particular expansion potential: Canadian banks and U.S. utilities. Canadian banks have increased issuance of $1,000 par securities with five-year reset structures, providing opportunities to potentially capture additional yield spreads. Utilities continue to expand issuance, including subordinated debt structures that qualify for preferred treatment while offering tax advantages to issuers.
Tax Advantages Enhance After-Tax Returns
Preferred securities provide meaningful tax benefits for taxable accounts under qualified dividend income rules. “Approximately two-thirds of the dividend is qualified dividend. Their taxable account on approximately two-thirds of the dividend, they pay their long-term capital gains rate, which is typically about half of their ordinary income rate,” Hodapp explains.
The tax advantage becomes more significant when comparing after-default yields across asset classes. High-yield bonds have averaged approximately 2.5% default rates over the past decade, while preferred securities show 10-year average default rates of just 0.5%. After accounting for expected defaults, high-yield bonds yielding about 7% provide roughly 4% after-default returns, while preferreds yielding 5.5% to 6% maintain approximately 5% to 5.5% after expected defaults, enhanced by favorable tax treatment.
Interest Rate Agnosticism Provides Portfolio Flexibility
The PREF structure allows advisors to remain relatively agnostic about interest rate direction while positioning for rising income potential. Reset features aim to provide protection in various rate environments, contrasting with traditional fixed-rate securities that face duration risk.
The strategy’s approach provides advisors with a tool for generating potentially competitive current income while positioning for possible coupon increases. PREF’s 5.5% average coupon, combined with the reset features across the portfolio, positions the fund for potential rising income, even in a declining-rate environment—a rare combination in fixed-income markets.
With the Federal Reserve likely to continue cutting rates and the average Spectrum reset spread of approximately 3.25 percentage points above five-year Treasuries, the mathematical foundation supports the potential for meaningful coupon increases. For advisors seeking income solutions that can adapt to changing rate environments while maintaining credit quality, PREF’s unique structure might addresses multiple portfolio objectives simultaneously.
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Additional Resources
- Contact Principal Asset Management
- Find out more about Spectrum Asset Management
- PREF Fact Sheet
- PREF Summary Prospectus
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Disclosures
1 As of July 31, 2025.
Carefully consider a fund’s objectives, risks, charges, and expenses. For a prospectus, or summary prospectus if available, containing this and other information, visit www.PrincipalAM.com or call sales support at 800-787-1621. Please read it carefully before investing.
ALPS Distributors, Inc. is the distributor of the Principal ETFs. ALPS Distributors, Inc. and the Principal Funds are not affiliated.
Unlike typical ETFs, there are no indices that the Principal ETFs attempt to track or replicate. Thus, the ability of the Fund to achieve its objectives will depend on the effectiveness of the portfolio manager.
Investing involves risk, including possible loss of principal.
Past performance is no guarantee of future returns.
Fixed-income investment options are subject to interest rate risk, and their value will decline as interest rates rise. Risks of preferred securities differ from risks inherent in other investments. In particular, in a bankruptcy preferred securities are senior to common stock but subordinate to other corporate debt. Contingent capital securities (CoCos) may have substantially greater risk than other securities in times of financial stress. An issuer or regulators decision to write down, write off or convert a CoCo may result in complete loss on an investment.
Asset allocation and diversification do not ensure a profit or protect against a loss. Investing in ETFs involves risk, including possible loss of principal. ETFs are subject to risk similar to those of stocks, including those regarding short-selling and margin account maintenance. Investor shares are bought and sold at market price (not NAV) and are not individually redeemed from the Fund. Ordinary brokerage commissions apply.
There can be no assurance as to the portion of the Fund’s distributions that will qualify for favorable federal income tax treatment. The Fund may make investments and pay dividends that are ineligible for favorable tax treatment or that otherwise do not meet the requirements for such treatment, and shareholders must satisfy certain requirements to take advantage of beneficial tax treatment.
ETFs can be tax efficient in that they are exchange-traded and redeem creation units from authorized participants by using redemptions in kind, which are not taxable transactions for the Fund. However, capital gains are still possible in an ETF, and if you reinvest the earnings of the ETF, you may owe taxes on your funds even if you didn’t sell any shares, potentially eating into your returns.
Spectrum Asset Management, Inc. is an affiliate of Principal Global Investors. Spectrum is a leading manager of institutional and retail preferred securities portfolios and manages portfolios for an international universe of corporate, insurance, and endowment clients.
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