With Treasury yields declining, these should be go-go days for interest rate-sensitive preferred stocks and exchange traded funds. 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.
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.
PFF is down nearly 7% year-to-date. The iShares preferred ETF and rival preferred funds are being dragged lower by declines in the financial services sector, the group that accounts for the bulk of preferred issuance.
“Most preferreds are issued by financial companies. Preferreds are subordinate to bonds and loans, but ahead of equities, in the capital structure. Bottom line — preferreds are only as secure as the banks that issue them. U.S. banks are much more well-capitalized now than they were doing the financial crisis. That means U.S. preferreds should do just fine in the long run and the sell-off could turn out to be a buying opportunity — once it stops,” reports Amey Stone for Barron’s.
While preferred stocks provide investors with an attractive source of yields, potential investors should keep in mind that 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]
Like bonds, preferreds are sold at par value, or offer a fixed or floating rate of income, so prices fluctuate with interest rates.
iShares U.S. Preferred Stock ETF
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.