With Treasury yields low and the S&P 500 home to an array of negative dividend action, the Global X Variable Rate Preferred ETF (PFFV) could prove to be one of this year’s best-timed new ETFs.
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.
PFFV follows the ICE U.S. Variable Rate Preferred Securities Index.
Income investors have looked to preferred stock ETFs in their portfolios for a number of reasons. 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.
Variable-rate preferreds usually trade more like bonds with shorter durations, so more conservative investors may find the lower-risk profile more appealing.
“Variable rate preferreds, on the other hand, have coupon payments that adjust at certain points over their life,” said Global X analyst Rohan Reddy in a recent note. “These issuances typically structure their coupon payments as floating rate or fixed-to-float. Floating rate preferreds are a subset of the market that adjusts their coupon payments on a regular schedule.”
With interest rates low, investors can use PFFV as an income-generating instrument now and as a hedge against future rate hikes because fixed rate preferreds have longer durations.
“Whether floating or fixed-to-float, these variable-rate preferreds can play an important role in investors’ portfolios as a low duration income-oriented asset class,” said Reddy. “Alongside other debt instruments that reset their coupons based on interest rates, like senior loans and floating rate treasuries, investors can use variable rate preferreds to reduce the duration, or interest rate risk, of their portfolios. This can be a particularly important feature during a rising interest rate environment, where investors are likely looking to reduce their portfolio’s duration.”
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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.