4 Ways Income Investors Can Benefit From Higher Rates

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Higher interest rates can create attractive opportunities for income investors.

These familiar sayings share a simple message: look for opportunity even when conditions aren't ideal.

Higher interest rates increase borrowing costs across the economy. Companies may delay marginal projects, slow acquisitions, or become more selective about investments. But businesses don't stop accessing capital altogether. They still need to refinance debt, maintain their assets, fund growth, and pursue attractive opportunities.

For income investors, this creates a silver lining.

When companies issue debt or preferred shares in a higher-rate environment, they generally need to offer investors more attractive yields than the U.S. Treasuries. This is exactly what we mean when we say the High Dividend Opportunities portfolio is rate agnostic. Our goal is to grow our income regardless of the interest-rate environment.

When rates are elevated, we can often secure higher yields without taking proportionally more risk. Think of driving down a slope. You don't need to accelerate much when gravity is already doing the work for you. 

Here are four ways we are putting today's higher rates to work.

Don't Wait For Rates To Fall

One of the biggest mistakes an income investor can make is waiting for the "perfect" environment.

Consider the housing market.

If you or your parents had refused to buy a house in the 90s, because mortgage rates were 7%–9%, they may have eventually enjoyed lower borrowing costs. But when rates fell (by 2012), other buyers gained purchasing power and property prices soared much higher. The result could have been paying considerably more for the same type of property.

The lesson isn't that an 8% mortgage is better than a 4% mortgage. It's that waiting for lower rates doesn't guarantee a better opportunity.

The same applies to income investing. If rates remain high, we collect the income. If rates eventually decline, fixed-rate securities can potentially appreciate, while issuers may have greater incentive to refinance or redeem expensive debt. As income investors, we don't need to predict exactly when the cycle turns. We can get paid to ride it.

Four Ways Income Investors Can Benefit From Higher Rates

1. Discounted Low-Coupon Preferred Stocks

When rates rise, older preferreds that were issued at low coupons become deeply discounted. For example, a $25 preferred paying a $1 annual dividend would yield 4% at par. But with rising rates, if the price falls to $17, a new investor earns ~5.9% on the same dividend payout..

The coupon hasn't changed. The purchase price has.

When rates eventually decline, the preferred could potentially recover toward its $25 liquidation preference.

While the issuer's financial strength and the security's terms remain critical, for larger, well-established institutions, a change in interest rates does not materially change their credit ratings, and the amount they spend on these preferreds does not change.

1. JPMorgan Chase & Co. 4.20% Series MM Preferred Stock (JPM-M) trading at $15.81/share currently yields 6.6%. This issuance is backed by the diversified operations of the largest bank in North America with $4 trillion in AUM. The preferred dividends enjoy substantial coverage, with no changes in the spend from the Fed’s 25 bps rate hike. JPM-M offers ~58% upside to par, and is well-positioned to deliver sizable capital upside when we are back in the rate cutting cycle.

2. 4.25% Capital One Financial Series N Non-Cumulative Perpetual Preferred (COF-L)  offers a 7.6% yield at its $14.47/share price, backed by the operations of the largest credit card lender in the world by loans outstanding and credit card portfolio size. COF-L continues to enjoy excellent dividend coverage and offers over 70% upside to par. Investors can expect sizable capital upside from this preferred as and when the Fed begins to lower rates.

   
   

2. High-Coupon Perpetual Preferred Stocks

Another opportunity is high-coupon preferred stocks trading around or below their liquidation preference. A $25 preferred with a 7% coupon pays $1.75 annually. At $25, that's a 7% yield. Due to its higher payout, rising rates generally have limited headwind effects on these securities, and they tend to trade closer to par.

When rates eventually decline, the issuer has incentives to refinance expensive preferreds at a lower cost. This makes redeeming a high-coupon preferred economically attractive. However, a call is never guaranteed and remains a discretionary move by the company. As investors, we want the security to remain attractive even if it stays outstanding indefinitely.

1. AGNC Investment 8.75 Fixed Rate Preferred (AGNCZ) currently trades slightly above par at $25.05, and offers an 8.7% yield. This preferred is not callable until October 2030, allowing investors to collect a healthy yield backed by a pure-play investor in agency MBS, one of the safest assets in the world. 

   
   

2. First Busey Corp Series B 8.25% preferred (BUSEP) also currently trades slightly above par at $25.16, offering an 8.2% QDI yield. BUSEP cannot be called until June 2030, allowing investors to lock a large qualified dividend for at least four years, backed by largely deposit-funded operations of one of the top 100 largest commercially chartered banks in the United States.

   
   

HDO just added a 9.7% yielding high coupon preferred with excellent issuer fundamentals. Join us to find out all about it.

3. Baby Bonds With Defined Maturities

Baby bonds offer another way to take advantage of higher yields. Unlike perpetual preferred stocks, baby bonds typically have a defined maturity date in addition to a call date.

Suppose a $25 baby bond currently trades at $23 and matures in 2029. Investors can collect the coupon while potentially receiving $25 at maturity. Issuer fundamentals are very important, as redemption is an obligation 

Investors are positioned to collect a healthy yield plus potential capital upside from the pull-to-par. The maturity doesn't eliminate credit risk, but it provides something a perpetual security doesn't – a defined endpoint for release of the investor’s principal for favorable reinvestment as they see fit. Such baby bonds issued by fundamentally sound companies tend to trade close to par despite changes in interest rates.

1. Adamas Trust 9.250% Senior Notes due 2031 (ADAMO) currently trades below par, and is not callable until April 2028, and matures in April 2031. This allows investors to secure a 9.7% yield from a mortgage REIT that has become highly conservative in its strategy, with a massive shift into agency MBS. ADAM has delivered three dividend raises in as many years, and continues to demonstrate excellent fundamentals to support investors across its capital structure.

2. Ramaco Resources 8.250% Senior Notes due 7/31/2030 (METCI) is callable after July 2027, and matures in July 2030, providing between 1-4 years of high yields from the lowest-cost producer of metallurgical coal in the U.S., with a rapidly expanding rare-earth metal mining operation in Wyoming. This baby bond trades slightly above par, offering an 8.2% yield.

   
   

4. Floating-Rate Preferred Securities

The fourth tool is floating-rate preferred securities, whose dividends are typically linked to a benchmark such as 90-day SOFR or the 5-year Treasury rate. Of the two, I generally prefer securities linked to 90-day SOFR, because the dividend resets more frequently and responds more directly to changes in short-term interest rates.

Floating-rate preferreds can be excellent tools for investors looking to grow income during a hawkish Fed cycle. As benchmark rates rise, the dividend on a floating-rate security can reset higher, increasing the investor's income without requiring the security price to rise.

However, this is a category I like less at today's prices.

The market already understands the benefit of higher short-term rates, and many of the higher-quality floating-rate preferreds trade at or above par. That means investors are paying up for the very protection that makes these securities attractive.

There is also an important downside when rates begin to fall.

With a fixed-rate preferred, a decline in rates can potentially push the price higher as its fixed coupon becomes more attractive. With a floating-rate preferred, the opposite tends to happen. The dividend payment declines as the benchmark rate falls, while the security's price can also come under pressure.

That creates a potential double hit to income investors – lower distributions and a lower market price. This is why floating-rate preferreds are generally a tool I prefer to buy when rates are already falling, rather than after a major period of rate increases has already been priced into the securities.

That said, the right tool depends on what you need from your portfolio. For investors specifically looking to increase their current income while the Federal Reserve maintains a hawkish stance, floating-rate preferreds can provide an excellent way to participate in higher short-term rates.

• Chimera Investment Corp Series D fixed-to-float preferred (CIM-D) trades past its call date, and its coupon resets every quarter based on the 3-Month SOFR + 0.2616% +5.379%, with its recent coupon at 9.36604%. This preferred trades below par, offering a 10% annualized yield to shareholders, backed by the operations of a hybrid mortgage REIT with a $16 billion portfolio.

  
  

What Happens When Rates Eventually Fall?

Interest-rate cycles change. We don't know exactly when the next meaningful move will occur, and we don't need to. If rates stay elevated, we continue collecting attractive income, and buy new issuances from quality companies and lock in higher yields, or discounted, older preferreds.

Let’s briefly talk about inflation. Currently, energy prices and tariffs are core factors governing the higher inflation. If gasoline rises from $70 to $100 but then remains around $100, the initial price increase raises the price level, but its direct contribution to year-over-year inflation eventually fades.

The same principle can apply to tariffs, a one-time increase in prices without producing permanently higher inflation. Today's elevated rates may not last indefinitely, and eventually the rate cycle will turn

The Bottom Line

A good friend of mine who loves winter told me:

I think the same principle applies to investing.

We cannot control inflation or interest rates. We cannot control when the Federal Reserve changes policy, how long rates remain elevated, or exactly when the next rate-cutting cycle begins.

What we can control is how we position our portfolio.

Higher rates can be challenging for borrowers, but they can also create opportunities for income investors. None of the securities discussed in today's article are risk-free. Credit quality, valuation, call provisions, maturity, and the underlying interest-rate exposure all matter. And that is precisely the point.

At High Dividend Opportunities, being rate agnostic does not mean ignoring interest rates. It means building a portfolio that can continue to generate attractive (and growing) income regardless of the rate environment.

We don't need to perfectly predict the weather. We just need to dress appropriately for it.

When rates are high, we make hay while the sun shines. We put today's higher yields to work, collect our income, and let time and the eventual rate cycle work in our favor 

Get paid while you wait. This is the beauty of our Income Method.

One week left to try High Dividend Opportunities for $34.90 for your first month, regularly $55. Rather than just remind you, we wanted to show you the kind of work members get every week. Start your trial at incomemethod.com/hdo before the offer ends October 7.