Preferred Stock ETF? No Thanks.

Roger Nusbaum submits: Market Participant has a post below about the need for a preferred stock ETF. I'm going to disagree for a couple of reasons.

The first reason is about investment merit and characteristics. ETFs help with single stock risk. The risk taken by owning a single-issue investment grade preferred stock is, reasonably speaking, quite low. The driver of volatility in a preferred stock is the maturity date and/or the call dates. This is easily controlled.

What about Enron and Worldcom-like fraud? Well, since those two, how many fraudulent blowups have there been? Very rarely in history do investment grade companies go away due to fraud -- it is statistically insignificant.

The other obstacle, more trading oriented, is liquidity of most preferred stock. The manager of a CEF can factor in liquidity and take time entering a position or get shares of a new issue if need be. An ETF provider needs to be able to meet creation-unit demand. To create shares of the ETF, the provider needs to either buy shares of the component holdings or buy futures on the way to buying the shares.

There are no futures or options for preferred stock. Buying a bunch of preferred stock in a reasonably short time period would be very difficult, if not impossible. Most of the time there are just a few hundred shares offered for sale.

I mentioned CEFs up above. Look at the chart action of some of the preferred stock CEFs and you will see that most of the funds are more volatile than the underlying holdings. This is because the market price can swing wildly in relation to NAV. An individual issue has its par value it has to go back to a CEF does not.