With the economy essentially stalling out over the first quarter, diminishing the likelihood of an interest rate hike any time soon, investors may be tempted to steer toward attractive yield-generating assets, such as preferred stock exchange traded funds.
Income investors may like preferred stock ETFs since the asset class offer stable dividends, don’t come with taxes on qualified dividends for those that fall into the 15% tax bracket or lower, are senior to common stocks in the event liquidation occurs, are less volatile than bonds and provide dividend payments before common shareholders, writes Dan Moskowitz for Investopedia.
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. Additionally, preferred stocks issue dividends on a regular basis, but investors are unlikely to enjoy capital appreciation on par with common shares.
However, while preferred stocks provide investors with an attractive source of yields, the assets are vulnerable in a rising interest rate environment. If rates rise, the holdings must decline in price to elevate their yield to attractive levels. Furthermore, most preferred stocks are either perpetual or long-dated, which exposes investors to significant interest-rate risk. [Evaluating Preferred ETFs Ahead of a Rate Hike]
For starters, investors can take a look at the iShares S&P US Preferred Stock Index Fund (NYSEArca: PFF), the largest preferred stock ETF, with $13.3 billion in assets. It tracks the performance of the S&P U.S. Preferred Stock Index, and has a 0.47% expense ratio and an attractive 6.06 12-month yield. The funds performance, though, is not too exciting, rising 2.9% year-to-date and 8.2% over the past year. Nevertheless, investors typically focus on the income aspect.
The PowerShares Preferred Portfolio (NYSEArca: PGX), which tries to reflect the performance of the BofA Merrill Lynch Core Plus Fixed Rate Preferred Securities Index, is another broad U.S. preferred stock ETF option. The fund has a 0.50% expense ratio and a 5.9% 12-month yield.
The SPDR Wells Fargo Preferred Stock ETF (NYSEArca: PSK) tries to reflect the performance of the Wells Fargo Hybrid and Preferred Securities Aggregate Index, and shows a 0.45% expense ratio and a 5.22% 12-month yield.