Traders and investors will be closely watching for tapering commentary that emerges from the Federal Reserve meeting later today. Owners of preferred stock ETFs could be hoping the Fed opts to delay tapering and keep its ultra-loose monetary policies in place for as long as possible.
Preferred stock ETFs were among the prime beneficiaries of the Federal Reserve’s near-zero interest rate policy. The iShares U.S. Preferred Stock ETF (NYSEArca: PFF), the PowerShares Preferred Portfolio (NYSEArca: PGX) and the SPDR Wells Fargo Preferred Stock (NYSEArca: PSK) benefited from investors’ thirst for yield in a low-interest rate environment. Investors enjoyed solid returns and yields often in excess of 5% with those ETFs and others. [Preferred Stock ETFs Flashing Ominous Signs]
A different chapter in the preferred ETF story was penned once tapering became part of everyday conversation for market participants. The market values of preferred stocks are affected by changes in interest rates, which left PFF, PGX and rival ETFs vulnerable to tapering talk. Since May 22, PFF is down nearly 8% while PGX is off 8.5%. [Interest Rate Concerns Weigh on Preferred Stock ETFs]
Preferred ETFs’ vulnerability in the face of rising interest rates is easy to explain. Not only are preferred stocks considered to be debt instruments, but the ETFs are usually heavily allocated to rate-sensitive sectors. There is talk that the largest U.S. banks could be crimped by rising rates and it is banks and diversified financials that comprise over 61% of PFF’s weight. Even if banks can endure higher rights, PFF is left vulnerable by real estate, utilities and telecom stocks combining for 19% of the fund’s weight.
Excluding financials is not a panacea for preferred ETFs as the Market Vectors Preferred Securities ex Financials ETF (NYSEArca: PFXF) proves. That fund has lost more than 8% since May 22. [Preferred Stock ETFs: Alternative Yield Source]
There is a bull case for preffereds and it is derived from the tapering-induced price decay inflicted upon the asset class.