In a challenging low-yield environment, the combination of active management and preferred stocks is potentially alluring for income-starved investors. Enter the Principal Spectrum Preferred Securities Active ETF (CBOE: PREF).

Preferred stock is a class of equity security that typically pay fixed or floating dividends to investors and have “preference” over common stock, but they are subordinated to bonds. The issuing company must pay dividends to preferred stockholders before common stockholders, and in the event of a bankruptcy or liquidation of the company’s assets, must put the claims of the preferred stockholders ahead of the claims of the common stockholders.

“Preferred shares fulfill different corporate financing goals. For investors, they can be an effective portfolio diversifier that delivers reliable income,” reports HCP Live. “If the worst happens and the issuing company tanks, preferred shareholders line up behind bondholders, but ahead of equity shareholders, for payment.”

PREF for Yield

With a yield of 4.80%, PREF checks the yield box at a time when investors are being left dry by Treasuries and stung by dividend cuts on common equities.

Preferred stocks are a type of hybrid security that shows 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.

There are other benefits to consider with PREF, particularly if the tax codes change after Election Day.

“Preferred shares’ after-tax yield of 3.6% is substantially above the yield of tax-free municipal bonds–2.7%–and corporate bonds’ after-tax yield of 1.4%. And it’s not far below the 4.1% after-tax yield of junk bonds, considering that preferred shares have a critical advantage over them: better credit quality,” according to HCP Live.

Like common stock, preferred stock is issued by a company and traded on an exchange. Preferred stock prices can fluctuate, but most of the returns from preferred stock come from dividends. Unlike common stock, preferred stock dividends are predetermined and paid at regular intervals. These dividends are paid in full before any dividends are released to common stockholders.

“Preferred investors need to worry about the credit quality of the issuing company versus that of individual issues. If they buy the preferred shares of high-quality companies, they don’t need to worry about where they would stand in a bankruptcy line because staying away from companies with poor credit makes this consideration moot,” according to HCP Live.

PREF’s active management can help investors avoid credit issues associated with preferreds.

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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.