Preferred stock, which combines features of common stocks and bonds, is another option for income-seeking investors besides dividend stocks, high-yield bonds, and real estate investment trusts.
How does Preferred Stock work?
“Preferred stockholders typically fall ahead of common equity holders and behind senior debt holders in a company’s capital structure,” explains Brandon Rakszawski, vice president and director of product management at VanEck. Preferred stocks are a special kind of stock due to their hybrid nature.
Unlike common shares, these assets don’t typically come with voting rights but make up for it in other ways. It’s important to note that preferred stocks typically generate more stable income than common dividend stocks or even corporate bonds.
According to Chris Manske, president and founder of Manske Wealth Management, preferred shareholders will be paid before common shareholders if the company is unable to pay the preferred dividends.
Preferred stock, like common stock, can see its value rise over time, albeit at a slower rate. Global X ETFs director of research Rohan Reddy suggests preferred shares for investors seeking stability and also yield with equity ownership.
However, investors should aware of some special dangers associated with these securities.
Preferred stocks, which are a type of hybrid security, are vulnerable to interest rate risk and other factors associated with fixed income, as noted by Rakszawski. Preferred stock prices, like bond prices, can drop when interest rates rise. These stockholders may be more credit risk than senior debtholders due to their lower capital structure positioning,” he says.
The 2008 financial crisis treated Preferred Stock like common stock.
However, preferred shares still face the possibility of price fluctuations. Derek Horstmeyer, a professor of finance at George Mason University, notes that “preferred shares behaved like a common stock during the 2008 financial crisis” in terms of their propensity to drop in value. Preferred stock, on average, lost 25% in 2008 while the S&P 500 fell 38%.
The time commitment and depth of knowledge required to select optimally preferred stocks a major drawbacks. To further complicate matters, “different preferred stocks may have different maturities, call provisions, conversion features, and coupon features,” as Rakszawski puts it.
For example, Manske agrees with Rakszawski that “diversification from buying shares of a billion-dollar preferred ETF is going to be greater than if an investor tries to pick preferred stocks on a case-by-case basis.”
The following seven ETFs provide exposure to preferred stocks for investors:
|PREFERRED STOCK ETF||EXPENSE RATIO|
|iShares Preferred and Income Securities ETF (ticker: PFF)||0.45%|
|VanEck Preferred Securities ex Financials ETF (PFXF)||0.4%|
|First Trust Preferred Securities and Income ETF (FPE)||0.85%|
|Invesco Preferred ETF (PGX)||0.5%|
|SPDR ICE Preferred Securities ETF (PSK)||0.45%|
|Global X U.S. Preferred ETF (PFFD)||0.23%|
|Global X SuperIncome Preferred ETF (SPFF)||0.58%|
Exchange Traded Fund iShares Preferred & Income Securities (PFF)
Stocks have market risk, and bonds have credit and interest rate risk, says Core Planning financial advisor Jordan Taylor. Preferred stocks “bridge both by taking a little of each,” he says, so they can be used to diversify an investor’s portfolio, increase returns, and hedge against losses in other asset classes. Buy PFF if you want to make a diversified wager on this asset category.
Approximately 66.5% of the 487 preferred stock issues held by PFF are issued by financial institutions. Moreover, the ETF has a low expense ratio of 0.45% and is passively managed; it follows the ICE Exchange-Listed Preferred & Hybrid Securities Index. PFF has a 6% yield on SEC investments with a 30-day maturity. With an AUM of around $12.6 billion. As a result, the ETF is one of the most sought-after vehicles for preferred shares.
Financials-Exclusive VanEck Preferred Securities ETF (PFXF)
Investors learned a valuable lesson about the dangers of sector concentration with the recent failure of Silicon Valley Bank. If you are nervous about PFF’s heavy weighting of preferred stock from financial sector companies, you may want to consider PFXF. This ETF follows the performance of an index composed entirely of non-financial company preferred stock on the ICE Exchange.
Many investors already have exposure to financials across their equity and fixed-income allocations, so PFXF gives them access to preferred stocks in utilities and real estate, as well, as Rakszawski explains. Furthermore, non-financial preferred securities have traditionally provided a marginal yield premium, shorter duration, and reduced call risk. The expense ratio for PFXF is 0.4%, and the 30-day SEC yield is 6.8%.
Income Trust Investing in Preferred Securities (FPE)
FPE may preferable to PFXF and PFF from the perspective of investors who prefer solutions that are actively managed. FPE does not track an index like the prior two ETFs did. In addition, the ETF’s management can allocate assets between preferred stocks, high-yield corporate bonds, and convertible securities. FPE has a higher expense ratio of 0.85%, making it more expensive than passive ETFs.
FPE’s holdings weigh toward preferred stocks issued by financial sector companies; specifically, banks (37.4%), insurers (20.7%), capital market firms (6%), and financial service providers (3.5%). Only 10% of the ETF’s holdings rated BBB+ or higher which indicates that the vast majority are speculative grade.
“A steady preferred stock ETF that checks all the boxes is PGX,” explains Manske of Invesco Preferred ETF (PGX), which is “not the biggest, not the most profitable, nor the most volatile, nor the most expensive.” What you want from an ETF like this is impressive vanilla simplicity, and that’s exactly what you get. In this case, ICE BofAML’s Core Plus Fixed Rate Preferred Securities Index followed.
There are, however, subtleties to consider. PGX does not hold all of the preferred stocks in the index; rather, the ETF employs a sampling approach to come up with a portfolio of 289 holdings that is intended to be representative of the underlying index. PGX also provides an options chain for investors seeking increased leverage. PGX has a 30-day SEC yield of 6.4% and also an expense ratio of 0.50%.
ETF on Preferred Stock Securities from SPDR and ICE (PSK)
PSK, which follows the ICE Exchange-Listed Fixed & Adjustable Rate Preferred Securities Index, is a preferred stock exchange-traded fund that satisfies more stringent investment criteria. Non-convertible, U.S. dollar-denominated, $25-par value preferred stocks that trade on the NYSE or Nasdaq and are rated investment grade by Moody’s or Standard & Poor’s are eligible for inclusion.
In addition, there must be at least 18 months until maturity and a trading volume of at least 250,000 units in the previous six months. Above all, PSK has a 71.8% allocation to financial sector preferred securities, the highest of any ETF on this list, and a 13.2% allocation to utilities, the second highest. The 30-day SEC yield on the ETF is 6% and also the expense ratio is 0.45%.
Preferred ETF manager Taylor says, “With a preferred stock ETF, you can offload the due diligence of picking individual preferred shares to an asset manager for relatively low cost” (PFFD). Firstly, select an asset manager with the right philosophy, investment style, and holdings. Top pick PFFD has a 0.23% expense ratio.
ICE BofA Diversified Core U.S. Preferred Securities Index is used as the benchmark for PFFD’s passive management style. The ETF currently owns 246 preferred issues from U.S. companies, all of which are involved in the financial industry. Monthly distributions have been made by PFFD for the past five years, and the yield on its 30-day SEC investment is currently 6.3%. In other words, the total assets under management for the ETF are just over $2.1 billion.
Exchange Traded Fund (ETF) Global X SuperIncome (SPFF)
“Preferred stocks pay dividends, usually fixed but sometimes variable. This ensures owners receive regular income “Reddy says. Preferred stocks are good portfolio diversifiers because they are uncorrelated to bonds and common stocks.
Global X provides SPFF, which tracks the S&P Enhanced Yield North American Preferred Stock Index to provide investors with exposure to the 50 highest-yielding preferred stocks in the United States and Canada. The ETF’s yield over the last 30 days as reported to the SEC is 6.7%, and it has distributed earnings monthly for the past decade. SPFF has an expense ratio of 0.58%.