Exchange traded funds that track preferred stocks provide investors with an attractive source of yields. However, as witnessed last year, preferred shares are vulnerable to rising interest rate environments.
As benchmark 10-year Treasury yields stay below 3%, Investors have found preferred stocks as an attractive alternative source of income. For instance the iShares U.S. Preferred Stock ETF (NYSEArca: PFF), the largest offering in the space with $8.7 billion in assets under management, shows a 6.33% 12-month yield. PFF has a 0.48% expense ratio. [Indexology: The Power of Dividends: Preferred Stock]
The fund, though has gained 5.3% year-to-date as Treasury yields have declined.
Nevertheless, with the Fed tapering its bond purchasing program and looking to the jobs market and economy as indicators for the eventual hike in benchmark rates, preferred stocks could be vulnerable ahead.
Preferred stock ETFs began to decline in May 2013 on Fed tapering and on concerns of rising interest rates. PFF is down 6.6% since its May 2013 high as benchmark 10-year Treasury yields gained over 100 basis points from a 1.63% low.
“Much like bonds, preferred stock becomes less attractive in a rising rate environment, so PFF’s holdings must decline in price to bring their yield up to an attractive level,” according to Morningstar analyst Abby Woodham. “Most preferred stock is either perpetual or extremely long-dated, which exposes investors to significant interest-rate risk.”