There’s Potential in Unique Preferred Stock ETF | ETF Trends

Preferred stocks and the related exchange traded funds are among income investors’ favorite destinations when interest rates are declining.

Obviously, the opposite is happening today, and with the April reading of the Consumer Price Index (CPI) checking in at 8.3% — barely beneath the 8.5% reading seen in March — the Federal Reserve could be prompted to accelerate its pace of rate increases to cool inflation.

More rate hikes could continue dragging on preferred stock ETFs, but some experts believe that preferred stocks are so badly beaten up that downside risk is now limited and there’s value. If that view is validated, the VanEck Vectors Preferred Securities ex Financials ETF (PFXF) could benefit.

PFXF, which tracks the ICE Exchange-Listed Fixed & Adjustable Rate Non-Financial Preferred Securities Index, is outperforming the widely observed ICE Exchange-Listed Preferred & Hybrid Securities Index by more than 100 basis points year-to-date. That’s one point in favor of PFXF. Value could be another.

“The preferred-stock market has suffered one of its worst selloffs in decades as yields on leading bank preferred issues have risen to about 6% from 4%. But with yields now at their highest levels in five years, the $350 billion market has gotten more attractive,” reports Andrew Bary for Barron’s.

The $964.8 million PFXF sports an impressive 30-day SEC yield of 5.69%, indicating that there is compensation for the rate risk involved with preferreds in the current environment. Speaking of rate risk, a case can be made that preferreds, including some PFXF components, have been too harshly repudiated this year.

“Some preferred issues have fallen nearly 30% in price this year—a huge decline for an asset class many investors have viewed as relatively low risk. The losses reflect the rise in long-term interest rates and a widening in yield spreads relative to Treasuries. Most preferreds are perpetual, which can make them acutely sensitive to rate changes,” according to Barron’s.

What’s interesting about PFXF outperforming rival preferred ETFs this year is that, as the fund’s name implies, it excludes the financial services sector — the group usually most positively correlated to rising rates. However, the sector is betraying that reputation this year, indicating it could be advantageous for PFXF to avoid it.

If nothing else, risk-tolerant income investors can snag some good deals and a strong income stream with PFXF today, along with the potential for long-term capital appreciation because preferred stock prices slumped so mightily.

“Buying preferreds at discounts to their face value mitigates one of the problems with the market. Preferreds generally can be redeemed by issuers in five years, limiting their upside. But if an investor buys a preferred at a sharp discount, there is considerably more appreciation potential,” notes Barron’s.

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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.