Time for Preferred ETFs?

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Markets have seen a wild start to the New Year, thanks to concerns related to the trading halt in China following the introduction of a new circuit breaker and cut in ties between Saudi Arabia and Iran. All major indices were in the red with more pains lurking ahead.

The Fed has already enacted a rate hike in December. Though gradual policy tightening is definitely a cause of concern, an unaccommodating global market backdrop led many investors to doubt the Fed's ability of being steadfast in hiking key rates throughout 2016.

Also, a lackluster earnings outlook for the fourth quarter of 2015 has made the matter worse, making investors apprehensive that last year's gloom is not over yet and that the market may see a replay of the 2015 sell-off, at least in the early phase of 2016.

Meanwhile, a flight to safety brought down the long-term U.S. treasury yields, even after the Fed lift-off. Investors are fleeing their risky securities for safe haven U.S. treasury bills. This unprecedented surge in demand for safe haven investments sent interest rates southward in recent sessions (read: Can Flight to Safety Save These Treasury Bond ETFs? ).

Still-contained interest rates despite the Fed rate hike increased demand for high yielding investment avenues. Though there are quite a few options, the current combination of relatively lower rates and higher equity risks makes investing in preferred stocks one of the most favored practices.

Investors should note that even if rates rise in the future on the Fed's continued policy tightening stance, many will still be looking for benchmark-beating yields and decent capital appreciation. For them, preferred equities and the related ETFs could be a great tool.

What is a Preferred Stock?

A preferred stock is a hybrid security that has characteristics of both debt and equity. These do not have voting rights but a higher claim on assets than common stock ( Complete Guide to Preferred Stock ETF Investing ).

That means that dividends to preferred stock holders must be paid before any dividend is paid to the common stock holders. And in the event of bankruptcy, 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 dividend on a preferred stock can be suspended or deferred by the vote of the board.

Preferred stocks generally have a low correlation with other income generating segments of the market like REITs, MLPs, corporate bonds and TIPs. However, unlike bond prices, these are also sensitive to downward changes in interest rates. If interest rates fall, issuers have the option to call shares and reissue them at lower rates (see all Convertibles/CEFs/Preferred Stock ETFs ).

Whatever the case, investors intending to tap this segment may play the below-mentioned ETFs.

PowerShares Preferred ETF ( PGX )

The fund holds a portfolio of 218 preferred stocks in its basket, tracking the BofA Merrill Lynch Core Plus Fixed Rate Preferred Securities Index. It charges 50 bps in fees.

Financials (86.3%) dominates this fund followed by utilities (6.1%). With the 30-day SEC payout yield of 5.78%, the fund too to is a solid income destination. It touched a 52-week high on January 4 and advanced 2.7% in the last three months (as of January 4, 2015).

PowerShares Financial Preferred Portfolio ( PGF )

The fund tracks the Wells Fargo Hybrid and Preferred Securities Financial Index, managing a fund size of $1.67 billion. Holding 86 preferred stocks in its basket, the fund provides an exposure to U.S. listed securities issued by financial institutions. The fund charges 63 bps in fees.

The fund has a notable 30-day Sec yield of 5.63% and an effective duration of 5.41 years indicating moderate interest rate risks. Like PGX, PGF too hit a 52-week high on January 4 and added 3.4% in the last three months (as of January 4, 2015).

iShares U.S. Preferred Stock ETF ( PFF )

The fund is the most popular preferred stock ETF in its space with an assets base of around $14.3 billion. The fund has an attractive payout, with the 30-day SEC yield at 5.34%.

PFF tracks the S&P U.S. Preferred Stock Index, holding 286 securities in its basket.  More than 60% of the fund assets are allocated toward financials (banks, financial services and insurance). The fund charges 47 basis points as fees to investors. It was up 0.9% in the last three months.

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PWRSH-PFD PORT (PGX): ETF Research Reports

PWRSH-FIN PFD (PGF): ETF Research Reports

ISHARS-US PFD S (PFF): ETF Research Reports

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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
Referenced Symbols: PGX , PGF , PFF

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