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New Preferred Stock ETFs Look To Disrupt Industry Titan


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The exchange-traded fund world has had one dominant force in the hybrid income securities that are preferred stocks over the last decade.  The iShares U.S. Preferred Stock ETF (PFF) has been the go-to spot for income investors that want the combination of high monthly yield and bond-like volatility.  This fund debuted in 2007 and has amassed over $16 billion in total assets as one of the most liquid and transparent funds of this sector.  It doesn’t hurt that as a Blackrock (iShares) vehicle, PFF carries with it the backing and reputation of a world-class ETF sponsor.

For years there has been little interest in competitors challenging this mantle.  Incumbents have been met with modest enthusiasm and the relatively small market makes for difficulty in creating differentiated or enhanced indexes.  That perspective may be changing as a swath of new funds enter the preferred stock arena in an effort to catch investor interest.

The Innovator S&P High Quality Preferred ETF (EPRF) debuted nearly two years ago as a competitive alternative to PFF.  This fund focuses on fixed-rate investment grade preferred securities with a credit rating of BBB or higher.  EPRF contains nearly 90 securities that are primarily weighted towards banks, insurance companies, and real estate stocks.  It also has a meaningful allocation to preferred stocks in the utility sector as well.

The goal of this fund is to seek out companies with higher quality financial ratings in an effort to minimize credit risk relative to PFF.  Such a focus will ultimately create a variant portfolio selection criteria and weighting methodology on a side-by-side comparison.  EPRF also carries an expense ratio of 0.47%, which is right in line with the cost of owning PFF.

Another PFF competitor taking on the tactic of lowest cost alternative is the Global X U.S. Preferred ETF (PFFD).  This new offering from Global X is designed to be a core preferred stock position with exposure to more than 200 holdings.  PFFD sports an expense ratio of 0.23%, which is the lowest in this group by more than half.

ETF investors have become increasingly sensitive to every basis point of savings they can achieve with these tools.  As such, PFFD has a serious chance of attracting fresh capital if the fund sponsor can successfully impart the message of how this fund competes with a similar portfolio and minimizes cost drag.  PFFD currently offers a 30-day SEC yield of 5.98% and income is paid monthly to shareholders. 

Finally, at the other end of this spectrum are two new actively managed preferred stock ETFs.  The Principal Spectrum Preferred Securities Active ETF (PREF) and First Trust Institutional Preferred Securities and Income ETF (FPEI) debuted within a month of each other late last year.  These funds are both attempting the difficult mission of outperforming the benchmark by accessing lesser-known areas of the preferred stock marketplace. 

PREF touts the ability to own both fixed-rate and floating-rate securities, which could potentially offer attractive capabilities through varying interest rate environments.  FPEI will also seek to achieve relative alpha through security selection and risk management of the underlying portfolio.  Both funds carry higher expense ratios than passive funds as can be expected from an active manager.

As these are the first active ETFs in this category, it will be interesting to watch their track record evolve compared to strict index funds.  Furthermore, investors should be wary that these funds will likely experience periods of outperformance and underperformance versus the benchmark. 

The Bottom Line

ETF investors are often set in their ways when it comes to long-held positions they are comfortable owning.  This is one of the reasons that assets in PFF have been so sticky over the years.  Nevertheless, many new funds can offer attractive cost propositions or variant portfolio positioning that may be suitable for rounding out a larger sector allocation in preferred stocks.  They are certainly worth a second look for those who value this income-generating sector. 

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.





This article appears in: Investing , ETFs , ETPs , Investing Ideas
Referenced Symbols: PFF , FPEI




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