Interest rates are likely to rise this month, and even if the Federal Reserve opts for an increase of 50 basis points, rates will still be low on an absolute basis, indicating that income investors still need to get creative.
Preferred stocks and the related exchange traded funds aren’t exotic instruments, but these assets offer above-average levels of income. That group includes the Invesco Preferred ETF (PGX). PGX is one of the more seasoned ETFs in this category and follows the ICE BofAML Core Plus Fixed Rate Preferred Securities Index.
At a time of underwhelming yields on U.S. government debt, municipal bonds, and broader equity benchmarks, the $6.75 billion PGX stands out with a 30-day SEC yield of 5.16%. Big yields are common in the preferred space and offer investors some protection, though not without some risk.
“Higher yields may be appealing, but they almost always come with the additional risks. However, lower yields that other investments offer can also be risky—in terms of maintaining purchasing power, meeting living expenses and so on. So there are tradeoffs,” writes Collin Martin of Charles Schwab.
Preferred stocks are considered hybrid securities, meaning that they possess both equity and fixed income characteristics. While preferreds, including PGX holdings, aren’t bonds in the typical sense, metrics such as credit quality, coupons, and duration are highly relevant to investors in this asset class.
For its part, PGX has an effective duration of 5.04 years, and 91% of its holdings are rated BBB or BB by Standard & Poor’s, according to issuer data. Those metrics are relevant to investors mulling PGX in relation to bonds or dividend-paying stocks.
“An issuer’s preferred securities will usually have a lower rating than the firm’s senior, unsecured bonds. Also, preferred securities are often compared to sub-investment grade, or high-yield, bonds, given the higher income opportunities. But remember, high-yield bonds, by definition, carry speculative-grade ratings, so they do come with credit risk,” adds Martin.
PGX, which recently turned 14 years old, holds 294 preferred stocks, and none of those components exceed an allocation of 1.67%. That indicates that single issue risk is muted in the Invesco fund. PGX charges 0.51% per year, or $51 on a $10,000 investment.
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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.