Preferred stocks and related exchange traded funds retreated along with other income-generating assets as U.S. yields spiked in response to the Federal Reserve’s tighter monetary policy, but the asset category may offer an attractive buying opportunity after the pullback.
The SPDR Wells Fargo Preferred Stock ETF (NYSEArca: PSK), one of the oldest preferred stock ETFs, is up almost 8% this year. PSK, which is almost 10 years old, follows the Wells Fargo Hybrid and Preferred Securities Aggregate Index.
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.
“Preferreds compare favorably to high-dividend stocks, investment-grade corporate bonds and the broader bond market,” said State Street in recent note. “While they yield less than high yield bonds, it’s worth pointing out that the index representing preferreds is nearly all investment grade rated.”
Perusing PSK ETF
PSK holds 156 preferred stocks and has a 30-day SEC yield of 5.13%, which is above what investors find on many investment-grade bond funds.
While preferred stocks provide investors with an attractive source of yields, 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.
The good news for investors considering a fund like PSK is that the Fed is not expected to raise rates this year and it is possible that a rate cut arrives later in 2019.
Preferreds can also act as an important portfolio diversifier because they have low correlations to other asset classes, including many fixed income groups.
“Preferred shares have low historical correlations to traditional stocks and bonds, indicating that their return patterns may be differentiated throughout certain market environments, resulting in a potential portfolio diversifier,” according to State Street.
PSK has almost $697 million in assets under management and charges 0.45% per year, or $45 on a $10,000 investment.
For more information on preferreds, visit our preferred stock category.