Preferred stock ETFs have delivered nicely for shareholders with steady returns, decent yields and low volatility.
The iShares S&P U.S. Preferred Stock Index Fund (NYSEArca: PFF) is the largest ETF in the category and pays a 12-month yield of 6%.
Now the fund is trying to break out to its highest level since the financial crisis after posting a total return of about 18% in 2012.
Preferred shares are hybrid securities that combine some features of stocks and bonds.
The $11.6 billion ETF has been remarkably stable while also paying investors a steady stream of dividends. The last quarter it suffered a loss was in Q3 2011.
“With yield so scarce today, investors are branching out into different asset classes in the search for income. Preferred stock can be a high-yielding addition to a diversified income-seeking portfolio,” says Morningstar analyst Abby Woodham.
So far this year, PFF has gathered nearly $700 million of new assets. In 2012, investors poured about $3 billion into the preferred stock ETF, according to IndexUniverse data.
“Preferred stock is a hybrid security usually issued by highly leveraged companies, such as financial institutions, telecoms, and utilities,” Woodham writes in a profile of PFF.
For example, PFF is heavily concentrated in the financial sector, including European banks.
Preferred shares pay higher dividends but don’t carry voting rights.
“Low correlations to other income assets make preferred stock a surprisingly good portfolio diversifier. The yield of preferred stock ETFs is almost unmatched on a risk-adjusted basis,” the Morningstar analyst notes.
PFF has a three-year standard deviation of 8.5 compared with 15.2 for SPDR S&P 500 ETF (NYSEArca: SPY).
Of course, preferred stock funds are not without risks – large stakes in the financial sector are an obvious one. Other risks include potential regulatory changes, rising interest rates, issuer bankruptcies and limited opportunities for capital appreciation, Woodham points out.
iShares S&P U.S. Preferred Stock Index
Full disclosure: Tom Lydon’s clients own PFF.