The recent surge in popularity of high yielding investment
avenues is not at all surprising, considering the desire for
income in this low rate environment. Fortunately, there are a
number of options available to investors from the ETF space to
focus on income.
While many investors have zeroed in on REITs, MLPs, and BDCs,
these have arguably become bid up as more search for high income
to fill the void in their portfolios. However, there is another
option that many may not have considered but could still be an
option for income, preferred stock.
What is Preferred Stock?
Preferred stock is a hybrid security that has the
characteristics of both debt and equity. Preferred stock does not
have voting rights but has a higher claim on the assets than
common stock (
Complete Guide to Preferred Stock ETF
That means that the dividends to preferred stock holders must
be paid before any dividends are paid to the common stock
holders. And in the event of bankruptcy, the preferred stock
holders' claims are senior to common stockholders' claims, but
junior to the claims of the bondholders.
The preferred stocks pay the stockholders a fixed, agreed-upon
dividend at regular intervals, like bonds. Most preferred
dividends have the same tax advantage that the common stock
dividends currently have.
However, while the companies have the obligation to pay
interest on the bonds that they issue, the dividends on preferred
stock can be suspended or deferred by the vote of the board.
Preferred stocks have generally a low correlation with other
income generating segments of the market like REITs, MLPs,
corporate bonds and TIPs (
Inside First Trust's New Preferred Securities ETF
Risk in Preferred Stock Investing
Although the yield provided by preferred stocks is impressive,
these are also subject to certain risks. Preferred stocks carry
the risk of regulation changes, higher interest rates and heavy
concentration in financials.
The price of preferred stocks on the secondary market in
general varies with interest rates, like bond prices. Investors
should thus keep in mind that a rise in interest rates will lead
to a fall in the value of these securities.
However, unlike bond prices, these are also sensitive to
downward changes in interest rates. If interest rates fall the
issuers have the option to call shares and reissue them at lower
Are Preferred Stock ETFs Worth the Risk?
How to Invest… Preferred Stock
One of the most popular preferred stock funds is the
iShares S&P U.S. Preferred Stock ETF (
. The fund manages an asset base of over $12 billion. This large
asset base is invested in a holding of 322 securities.
These securities are mainly from the diversified financials,
banks, and real estate sectors. In fact, diversified financials
and banks take way almost 62% of the fund while another 11.35% is
allocated to the real estate sector.
The current 30-day SEC yield on PFF is 5.51% and the fund
charges a fee of 48 basis points annually (
Two Unconventional Sources of ETF Yield
Looking at the above, it is quite clear that the price of the
fund has been steadily appreciating in the last one year period.
In fact, currently the fund is trading near its all time high.
The fund has delivered a return of 6.9% over a period of one year
while its year-to-date returns stand at 3.1%.
In this low rate environment, investing in preferred stock
ETFs has become very popular as they offer a steady source of
income and a yield near the 6% level obviously makes the ETFs all
the more attractive.
Other ways to tap the segment in basket form include:
SPDR Wells Fargo Preferred Stock (
Launched in Sep 2009, PSK tracks the pre expenses price and
yield performance of Wells Fargo Hybrid and Preferred Securities
The ETF holds 138 securities in which it invests an asset base
of $393 million. The ETF does well in eliminating concentration
risk as it holds a mere 20.51% of its total assets in its top 10
The fund charges only 45 basis points in fees and expenses,
one of the lowest in this category. The ETF pays out a solid
yield of 6.30%, making it ideal for investors seeking high levels
of current income (
What Does Your Income ETF Focus On?
In the past one year, the fund has returned 3.7% and has
delivered a return of 3.2% year to date.
PowerShares Financial Preferred ETF (
This product tracks the Wells Fargo Hybrid & Preferred
Securities Financial Index which is a capitalization weighted
index tracking the performance of preferred securities issued by
financial institutions in the U.S. markets.
The fund holds 59 securities presently and allocates 45.65% of
its assets in the top 10 holdings. Like most of its counterparts,
PGF pays out an impressive yield of 6.17%.
It has returned a decent 5.7% in the last one year charging
investors 66 basis points in fees and expenses. The expense ratio
of this ETF happens to be one of the highest in the preferred
stock ETF space.
In this low rate environment, preferred stock ETFs offers an
interesting source of yield for income hungry investors. Plus,
they generally have lower levels of volatility than common
stocks, and are not as bid up as other high yielders that are
However, they can be sensitive to interest rate changes, so
monitor bond markets closely. If the interest rates rise going
forward it will lead to a fall in prices of preferred stocks
thereby leading to lower returns for investors.
But until that happens, preferred stock ETFs could be
interesting picks in today's economy that provide outsized income
payments to investors, that is uncorrelated to broad markets as
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ISHARS-SP PFD S (PFF): ETF Research Reports
PWRSH-FIN PFD (PGF): ETF Research Reports
SPDR-WF PFD STK (PSK): ETF Research Reports
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