Through years of the Federal Reserve’s near-zero interest rate policy, exchange traded funds holding preferred stocks gobbled up assets from income investors. However, with rates to set rise as soon as next month, rate-sensitive preferreds and the relevant ETFs could come under pressure.
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.
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.
The iShares U.S. Preferred Stock ETF (NYSEArca: PFF) and the PowerShares Preferred Portfolio (NYSEArca: PGX), each with trailing 12-month dividend yields in the area of 6%, are among the marquee preferred ETFs.
“If interest rates remain low, and the economy remains stable, preferred stocks funds should prosper. Preferred ETFs have low volatilities so are excellent choices for the risk averse investor. Among the ETFs, four had the similar performance: PGX, PGF, PFF, and PSK. If you had to choose one, I would go with PGX or PGF,” according to a Seeking Alpha analysis of preferred ETFs.