Preferred Stock ETFs And Rising Rates

Includes: PFF
by: Tom Lydon

Preferred stock ETFs could suffer more losses if interest rates start ticking higher again after this week's breather.

"Preferred stock faces various headwinds, particularly rising interest rates," according to Morningstar analyst Abby Woodham. "When rates rise, preferred stock prices fall as their attractiveness declines. Most preferred stock is either perpetual or extremely long-dated, which exposes investors to significant duration risk. Even the whisper of rising rates can send these securities' prices lower."

Traders were quick to pick up preferred stocks as a go-to income generating asset during the recent low yield environment.

The iShares S&P US Preferred Stock ETF (NYSEARCA:PFF), though, declined 2.3% over the past three months as the markets speculated the Fed would begin reducing its bond purchasing program sooner rather than later. Additionally, investors pulled $1.1 billion out of since the end of April, according to IndexUniverse data.

Preferreds fall somewhere between bonds and stocks. Preferred share dividends take precedent over common share dividends but fall below bonds in a company's debt obligation hierarchy. However, they do not benefit from earnings growth of the issuing company.

The securities are also callable - an issuer can call the preferred stock and pay the investor at a pre-defined redemption price. In a rising rate environment, preferred shareholders are essentially stuck at the original rates.

The preferred stocks are typically issued by financial institutions, utilities and telecom companies.

iShares S&P US Preferred Stock ETF

Max Chen contributed to this article.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.