What impact has the government’s purchase of preferred financial shares in the country’s major banks had on the financial preferred exchange traded fund (ETF)?

Preferred stock was purchased by the government to the tune of $100 billion when the Troubled Asset Relief Plan was unveiled late last year. Preferred shares are a higher class of stock, and holders of preferred shares don’t have voting rights, but they get paid dividends before common shareholders.

Now the government has been talking about making the conversion to common stock, which could be beneficial to taxpayers if it takes place. Why? If these banks have a little extra common stock cushion, it could make them less likely to take bad bets that cost tax-paying citizens dearly. But it still will mean more risk, because there’s no way of knowing what those shares are going to be worth when it comes time to sell, and America could be on the losing end.

The reason for the conversion is, in essence, to make the TARP money go a little further. Converting those loans to common shares would turn the federal aid into available capital for a bank — and give the government a large ownership stake in return, reports Edmund L. Andrews for The New York Times. Additionally, it would provide additional capital to major banks at no additional cost.

Invesco PowerShares’ Senior Vice President of Portfolios Strategies Ed McRedmond said the PowerShares Financial Preferred (PGF) saw some benefit as Americans grew more concerned about the health of the nation’s banks.

“When the government came in and invested capital through the preferred shares, we saw activity in the preferred ETFs increase.”

In fact, both of PowerShares’ preferred ETFs (the other is PowerShares Preferred (PGX)) have seen positive inflows since the financial mess intensified.

“Year-to-date, you’re talking a few hundred million dollars into the funds. Even last year, they saw positive net inflows,” McRedmond says.

Year-to-date, PGF has seen $276 million in net inflows.

Part of the rush of inflows was because of last year’s suspension of financial stock short-sales. “All of a sudden, you had institutional investors and hedge funds looking for ways to trade financial markets.”

Preferred stock can be more appealing to investors who want financials exposure, but are wary of how beaten-down the sector has become.

“People might not have been comfortable buying the common stock, but they wanted to have a way to gain exposure to the sector for any recovery, while earning a dividend,” McRedmond says, noting that many financials have eliminated or reduced dividends on their common stock.

Another reason the preferred financial stock might have gotten a boost is because big-name investing gurus such as Pimco’s Bill Gross highlighted the fact that investors should go where the government goes.

“It sparked a great deal of interest when Bill Gross said he was buying bank preferred stocks.”

• PowerShares Financial Preferred (PGF): down 9.5% year-to-date

Tags: ETF 101, Feature Stories, Financial, Interviews, PGF, PGX, Sector ETFs