Preferred stock ETFs could suffer more losses if interest rates start ticking higher again after this week’s breather.
“Preferred stock faces various headwinds, particularly rising interest rates,” according to Morningstar analyst Abby Woodham. “When rates rise, preferred stock prices fall as their attractiveness declines. Most preferred stock is either perpetual or extremely long-dated, which exposes investors to significant duration risk. Even the whisper of rising rates can send these securities’ prices lower.”
Traders were quick to pick up preferred stocks as a go-to income generating asset during the recent low yield environment.
The iShares S&P US Preferred Stock ETF (NYSEArca: PFF), though, declined 2.3% over the past three months as the markets speculated the Fed would begin reducing its bond purchasing program sooner rather than later. Additionally, investors pulled $1.1 billion out of since the end of April, according to IndexUniverse data. [High-Yield, Preferred Stock ETFs’ 2013 Gains Vanish in Rate Spike]
Preferreds fall somewhere between bonds and stocks. Preferred share dividends take precedent over common share dividends but fall below bonds in a company’s debt obligation hierarchy. However, they do not benefit from earnings growth of the issuing company. [Preferred Stocks]
The securities are also callable – an issuer can call the preferred stock and pay the investor at a pre-defined redemption price. In a rising rate environment, preferred shareholders are essentially stuck at the original rates.