After Drubbing, Preferred Stocks ETFs Look Interesting | ETF Trends

Preferred stocks and related ETFs certainly fit the bill as high income assets. That’s a positive when interest rates are declining or low, but the opposite is true in rising-rate environments.

In other words, it’s not surprising that preferred stocks and ETFs such as the VanEck Preferred Securities ex Financials ETF (PFXF) are struggling this year against the backdrop of five rate hikes by the Federal Reserve.

On the other hand, investors still need income, and following the bloodletting incurred by preferreds earlier this year, the asset class is starting to look appealing, indicating a fund such as PFXF could be worthy of evaluation by income investors.

“The average preferred stock fund boasts a 6.14% SEC yield—an estimate of a fund’s future 12-month yield—higher than the average intermediate-term bond’s yield at 3.59% as of Sept. 30. Meanwhile, the Morningstar Dividend Composite Index was yielding 3.2% at the end of last month,” notes Morningstar analyst Katherine Lynch.

Preferred stocks are considered hybrid securities, meaning they exhibit traits of both bonds and equities. That explains a significant part of the group’s struggles this year because stocks are in a bear market while bonds are being slammed at the hands of the aforementioned rate-hiking regime.

Speaking of performance, apparently, there’s something to the exclusion of preferred stocks issued by banks – PFXF’s methodology – because the VanEck ETF is sharply outperforming the largest ETF in this category over the past three years. Additionally, preferreds outperform traditional equity benchmarks this year while offering superior income levels. That’s notable because preferreds’ correlations to standard equities has been somewhat high in recent years.

“Over the past five years, preferred stocks tracked the performance of the Morningstar US Market Index closer than the Morningstar US Core Bond Index. The Bank of America Merrill Lynch Core Fixed Rate Preferred Securities Index shows a 0.78 correlation to the Morningstar US Market Index, while only a 0.59 correlation with the Morningstar US Core Bond Index,” adds Lynch.

Of course, there’s credit risk with preferreds, as is the case with any high-yield asset. Fortunately, about a third of the ETF’s holdings carry investment-grade ratings. Among the 27.20% that sport junk ratings, none reside in the dubious CCC space. Forty percent of PFXF’s 122 holdings are not yet rated, according to issuer data.

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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.