Investors in preferred stock ETFs would be hard-pressed to find a reason to complain. Over the past year the sector has consistently delivered solid performance, high 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%. Preferred shares are hybrid securities that combine the features of stocks and bonds.
PFF and other preferred stock funds have so far has been relatively immune to the recent pullback in other high-yielding ETFs such as junk bonds and emerging market debt. [High-Yield, Emerging Market Bond ETFs Lead Outflows]
The fund has delivered a total return of more than 10% for the trailing year, and with very low volatility to boot.
“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,” writes Morningstar analyst Abby Woodham in a profile of PFF.
“Low correlations to other income assets make preferred stock a surprisingly good portfolio diversifier,” she adds. “The yield of preferred stock ETFs is almost unmatched on a risk-adjusted basis.”
For example, PFF has a three-year standard deviation of 8.5, a little more than half the 15.2 standard deviation for SPDR S&P 500 (NYSEArca: SPY), according to Morningstar.
“The bank preferred market has shown lower volatility in both directions — in November 2012 when the overall market was down over 5% mid-month, bank preferreds were only down 2%,” writes Ryan Brennan at Preferred Stock Research. “With a low volatility asset it’s easy to feel like you’ve missed something when the overall market outperforms and everyone quickly forgets the smaller declines to the overall market. Investors need to remember that in the long run, ‘steady as she goes’ is a pretty solid investment thesis.”
Other ETFs for the category include PowerShares Preferred Portfolio (NYSEArca: PGX) and SPDR Wells Fargo Preferred Stock ETF (NYSEArca: PSK).
However, the sector does come with certain risks. “Heavy exposure to financials, regulation changes, and rising interest rates are foremost on this list,” Woodham notes.
“Issuance from various financial companies makes up almost 90% of PFF, so investors worried about the future of the industry should stay away from this asset class. Preferreds are sensitive to interest rates, but unlike bonds, they are at risk in both directions,” the analyst said.
iShares S&P U.S. Preferred Stock Index Fund
Full disclosure: Tom Lydon’s clients own SPY.