Preferred stock ETFs have been trading flat the past couple months along with the major equity indices, but their high dividend yields compensate investors while they wait for the next big move. Still, preferred ETFs come with unique risks, including concentration in the global financial sector amid Europe’s lingering debt crisis.

Preferred stock funds are another option for investors that are keen to the yield and income theme.

“Preferreds are hybrid securities that have characteristics of both stocks and bonds and are typically issued by financial institutions, utilities, and telecom firms. It makes regular income payments and is rated by the major credit-rating agencies. Preferreds have no voting rights, are senior in the capital structure to common stock, and have priority over common stock in the payment of dividends. Even though it is an equity security, it does not participate in the earnings growth of the company and the resulting common stock appreciation. It is priced similarly to long-term corporate bonds with a little higher credit risk,” Timothy Strauts for Morningstar wrote in a recent analyst report. [Three Dividend ETFs for Investors Aiming High]

The largest and most popular focused ETF is the iShares S&P U.S Preferred Stock Index Fund (NYSEArca: PFF). which has about 245 holdings and an expense ratio of 0.45%. PFF has a 12-month yield of 6.99%. Financials make up about 46.6% of the holdings, and banks at 25.4%. PFF has been “quiet” for the past few months since the January and February financial sector rally. PFF is up about 3.8% over the past 6 months. [ETF Spotlight: Preferred Stock ETFs]

Financial institutions make up over 85% of most preferred issuance, so the major factor affecting preferred stock prices is the sentiment of the credit quality in the financial sector. This can be considered a risk, considering the instability that the sector went through over the past few years.  [Preferred Stock ETFs Enjoy Fat Yields, Capital Appreciation]

Preferred stocks have various factors affecting their future risk. The three major characteristics of these shares are the type of dividends they pay, their payment schedules and their ratings, along with their ability to be converted into the company’s common stock, reports Doug K. Le Du for Seeking Alpha. Together, the aforementioned all affect the amount of risk in a preferred stock fund. However, some investors can use these traits to actually manage risk within their portfolio.

Other preferred stock ETFs:

  • PowerShares Preferred Portfolio (NYSEArca: PGX) yields 6.6%
  • PowerShares Preferred Financial (NYSEArca: PGF) yields 6.9%
  • SPDR Wells Fargo Preferred Stock (NYSEArca: PSK) yields 3.1%

iShares S&P U.S Preferred Stock Index Fund

Tisha Guerrero contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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