Amid historically low interest rates and no threat that the Federal Reserve would deviate from that course, exchange traded funds holding preferred stocks became favored destinations for yield-hunting income investors.
With the interest rate outlook appearing far less sanguine as the Fed readies to boost borrowing costs, perhaps as soon as June, advisors and investors should take the opportunity to assess the place preferred ETFs in portfolios.
Preferred stocks are a type of hybrid security that show bond- and equity-esque characteristics. The shares are issued by financial institutions, utilities and telecom companies, among others. Within the securities hierarchy, preferreds are senior to common stocks but junior to corporate bonds. Preferred stocks issue dividends on a regular basis, but investors are unlikely to enjoy capital appreciation on par with common shares. [Rate Risk With Preferred ETFs]
High yields coupled with preferred shareholders having a better seat at the table in the even of issuer default than do common shareholders have been among the sources of allure for ETFs such as the iShares U.S. Preferred Stock ETF (NYSEArca: PFF) and PowerShares Preferred Portfolio (NYSEArca: PGX).
The $13 billion PFF has a 30-day SEC yield of 5.48% while the $2.82 billion PGX has a 30-day SEC yield of 5.91%. It is yields like that require advisors and investors to answer important question as Treasury yields ebb higher: Are preferred stocks behaving more like bonds or common equities? [Preferred ETFs Loving Falling Rates]
“Over a three year period, the annualized returns of the U.S. preferred market have been more bond like than equity like. The S&P U.S. Preferred Stock Index had a three year annualized return of 7.95% while long U.S. Treasury bonds have returned 8.14%. Meanwhile, the three year annualized return of the S&P 500 has been well over 15%,” notes J.R. Rieger, global head of fixed income at S&P Dow Jones Indices.
Investors seem to be buying into the notion that preferred ETFs behave more like stocks than bonds. As much is highlighted by the combined 2015 inflows of roughly $1.6 billion into PFF and PGX.