There's Power in Preferred ETFs

Preferred stocks and the related exchange traded funds are high-yielding, income-generating assets. The downside is that such assets are often perceived to be vulnerable to rising interest rates, but the iShares S&P US Preferred Stock Fund (NASDAQ: PFF) is higher by nearly 2.60% year-to-date.

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.

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.

Preferred Perks

Preferred stocks and ETFs like PFF are suitable for long-term, income-minded investors.

“As part of a long-term growth portfolio, consider carving out a portion for high-income strategies. It might be worth suffering some price drawdowns while reinvesting any income received in the same income-producing investments,” said BlackRock in a recent note.

The $17.19 billion PFF, the largest preferred ETF by assets, targets the S&P U.S. Preferred Stock Index and holds over 300 preferred stocks. Following the global financial crisis, financial services firms were major issuers of preferred stock. That is reflected in PFF as over 59% of the fund’s holdings are issued by banks or diversified financial firms.

“The iShares U.S. Preferred Stock ETF (PFF) provided a 30-day SEC yield of 5.4% as of July 31, and the lion’s share of its dividend distributions constitute lower-tax-rate qualified dividend income (QDI) – making it tax efficient,” according to BlackRock.

For more fixed income investment solutions, visit the Fixed Income Channel.

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.