The largest ETF for preferred stocks, known for their above-average yields, is trying to break out to the highest level since 2008.
The iShares S&P U.S. Preferred Stock Index Fund (PFF) posted a total return of 18.2% in 2012 to outpace the 16% gain for the S&P 500, according to Morningstar.
For investors, preferred stock ETFs delivered the best of both worlds last year. They saw nice capital appreciation with less volatility, along with a healthy yield.
For example, PFF has a 12-month yield of 6%, according to manager BlackRock (BLK). It holds about $11 billion in assets.
The preferred share ETF is trading around $40 a share and a break above $41 would carry the fund to post-financial-crisis highs.
"Preferred stock is a surprisingly good diversifier: it has low correlation to other income-generating asset classes like REITs, MLPs, corporate bonds, TIPS, and popular income ETFs," according to Morningstar analyst Abby Woodham.
However, there are some risks, such as "heavy exposure to financials, regulation changes, and rising interest rates are foremost in this list," Woodham added.
Preferred stocks are a type of hybrid security that exhibit the characteristics of equity and bond instruments. The shares are predominately issued by financial institutions, utilities and telecom companies. Preferred share dividends take precedent over common share dividends but fall below bonds in a company's debt obligation hierarchy.
As many investors have noticed, this class of stocks provides high yields, but unlike regular stocks, the dividends are fixed, so investors can rely on a relatively stable source of income.
In the current market environment, it could be tough for preferred stocks and ETFs to continue generating attractive returns, writes Dan Caplinger for the Motley Fool. Specifically, if companies outperform, investors would be better of in common stock, and if the Fed does decide to raise interest rates sooner than expected, preferreds would take a hit from the higher rates.
Some other preferred stock ETFs include:
- PowerShares Preferred Portfolio (PGX): 6.40% 30-day SEC yield; up 13.2% over the past year
- PowerShares Financial Preferred Portfolio (PGF): 6.46% 30-day SEC yield; 17.9% over the past year
- SPDR Wells Fargo Preferred Stock ETF (PSK): 5.37% 30-day SEC yield; 11.7% over the past year
Max Chen contributed to this article.
Full disclosure: Tom Lydon's clients own PGF.