SPDR, Wells Fargo Team Up to Launch New Preferred Stock ETF

By Patrick Watson

SPDR Wells Fargo Preferred Stock ETF (PSK) started trading yesterday (September 17, 2009). This is the fourth ETF to cover this niche; SPDR obviously saw a hole in their product guide and did not want to leave the space to iShares U.S. Preferred Stock (PFF), PowerShares Preferred Portfolio (PGX), and PowerShares Financial Preferred Portfolio (PGF). Those funds have been doing quite well this year, once they got past the devastating first couple of months.

Income-oriented investors like preferred stocks because they generally have a fixed dividend payout and also the potential for price appreciation. PSK tracks an index of such stocks, almost all of which come from the financial sector. Top holdings include issues from HSBC, Barclays, Allianz, Credit Suisse, and Deutsche Bank.

As of 8/31/09 the index on which PSK is based had a dividend yield of 8.4%. This may sound attractive, but investors should keep in mind that higher yields usually reflect higher risk. “Investment Grade” no longer means what it once did. On the other hand, governments and central banks around the world have made it clear that major financial institutions will not be allowed to default – even if it means letting taxpayers cover their liabilities. No one wants another Lehman Brothers debacle. PSK is not exactly a Treasury bond fund, but probably does not carry the risk level that preferred stocks did in the pre-bailout era.

PSK has an expense ratio of 0.45% and the portfolio includes 164 preferred stock issues. As noted above, financial sector exposure is heavy at almost 90%, with the balance coming mostly from telecom and utilities. PSK should be a decent alternative for those who want a slice of their portfolio in preferred stocks.

PSK Fact Sheet (pdf)

Disclosure: No positions

Comments

[bearfund:]

If risk is lower, it's not because of government policies. It's been made very clear that while megabanks' bondholders will be protected from catastrophic loss, shareholders enjoy no such protection. Banks are so highly leveraged that the liquidation preference in these issues is worthless; if one of these issuers gets into real trouble you should expect to recover nothing, even if a government takes it over and guarantees its debt.

Remember, preferred is the new common. You should think of the risks and rewards of these shares similarly to how you would think of the common stock of a non-financial company. That anyone owns bank common is something of a mystery; the reason to own common instead of preferred is to take advantage of share appreciation as earnings and dividends grow. But with most financial common yielding less than 1% with high payout ratios and rich valuations relative to book, where's the upside there? Those shares are already priced to reflect years of improving balance sheets and dividend increases, neither of which is a certainty. The preferreds are priced in a way that reflects most of the risks. The wild card? Interest rate risk. When interest rates start rising, watch out. That 8.4% yield is only about 500bp cheap to the 10-year T-note. While that will tighten considerably if a real recovery does ever get underway, it would be very surprising not to see the 10-year note yield 8% at some point in the next 5 years (this is near historical norms). When that happens the prices of these preferreds will fall, no matter how healthy their issuers.

Sep 20 01:37 PM

[Alan Young:]

All of the 5 top holdings are European! The biggest gains (or losses) could come from currency trends, not interest. This is a completely different picture... but the fact sheet says nothing about currency exposure or hedging. Better do more digging into the prospectus.

Sep 20 05:09 PM