The iShares S&P US Preferred Stock Index Fund (NYSEArca: PFF), the largest preferred stock exchange traded fund, and rival preferred ETFs are often viewed as sensitive to interest rate increases.
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.
To PFF’s credit, the ETF is up 4.4% year-to-date and has traded modestly higher following the Federa; Reserve’s first interest rate hike of 2017, which was announced earlier this month. Some active managers are concerned about the size of PFF relative to the preferred market as a whole.
As of March 23, PFF, which is 10 years old, had $17 billion in assets under management, according to issuer data.
“Due to the dramatic growth PFF has experienced over the last 9 years, and the small market size it replicates, the PFF now holds over 10% of overall issue size of the preferreds used in the ETF. For example the largest weighting in the PFF is a Wells Fargo preferred that has a total issue size of $4 billion, the PFF owns $488 million, roughly 10% of the entire issue,” said Nat Beebe of Ulland Investment Advisors in an interview with Amey Stone of Barron’s.
Other well-known preferred ETFs include the PowerShares Preferred Portfolio (NYSEArca: PGX) and the Global X SuperIncome Preferred ETF (NYSEArca: SPFF).
Income investors have looked to preferred stock ETFs in their portfolios for a number of reason. For instance, the asset class offers stable dividends, does not come with taxes on qualified dividends for those that fall into the 15% tax bracket or lower, is senior to common stocks in the event liquidation occurs, is less volatile than bonds and provides dividend payments before common shareholders.
“Keep in mind that during the 2013 rate rise the PFF saw a 27% reduction in outstanding shares, so a 10% redemption assumption may prove to be conservative. Using this framework, it is clear that the PFF faces severe challenges in providing an orderly liquidation for investors,” Beebe said to Barron’s.