Preferred stocks and exchange traded funds, such as the the iShares S&P US Preferred Stock Index Fund (NYSEArca: PFF), the largest preferred stock ETF, are among the high-yield, income-generating asset classes that have recently come under pressure as investors price in rising odds that the Federal Reserve will finally boost interest rates next month.
Preferred stocks are a type of hybrid security that show bond- and equity-like 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 don’t usually enjoy capital appreciation on par with common shares.
Still, income investors should be careful about being too eager to dump preferreds simply because one rate hike appears imminent. In fact, some market observers argue that the recent decline by preferreds is creating value in the asset class.
Alternatively, investors may also consider the PowerShares Variable Rate Preferred Portfolio Fund (NYSEArca: VRP in a rising rate environment. Variable-rate preferreds usually trade more like bonds with shorter durations, so more conservative investors may find the lower-risk profile more appealing. Although VRP is a lower duration product, it does yield over 5%.