Preferred stock exchange traded funds have helped income-oriented investors cash in on robust yields, but rising interest rates are beginning to dampen the investment's appeal.
The iShares S&P US Preferred Stock Index Fund (PFF) has gained 0.8% year-to-date, but the fund has declined 4.2% over the past month on concerns that the Fed will taper its bond-purchasing program. PFF has a 5.79% 12-month yield.
"The interest rate risk is a disadvantage in today's environment, given where rates are," James Holtzman, wealth manager at Legend Financial Advisors, said in a Fox Business article. "Rates have nowhere to go but up."
The market value of preferred stocks are affected by changes in interest rates. When rates rise, prices on the investments go down, but the effect is less noticeable on preferred stocks than fixed-income assets.
Many preferred shares are also callable - an issuer can call the preferred stock and pay the investor at a pre-defined redemption price. In a rising interest rate environment, preferred shareholders are essentially stuck at the original rates.
Preferred stocks have seniority over common stocks for payments due in the event of bankruptcy. If a company goes under, bond investors get their share first, followed by preferred stock investors.
Investors who still want to keep their exposure to preferred may be better suited with a diversified ETF.
"Buying individual stocks requires a lot of research and time. It's best left to pros," according to Abby Woodham, an ETF analyst at Morningstar. "For investors who don't have the time and desire, ETFs are a good, cheap alternative. What's the likelihood you will beat the index if you do the research? Probably low."
iShares S&P US Preferred Stock Index Fund
Max Chen contributed to this article.