Recent growth in the ETF industry has been due in large part to surges in popularity of asset classes to which many investors would otherwise have fairly limited access. Exchange-traded commodity products have seen billions of dollars in cash inflows, as have fixed income and currency funds. While the number of ETFs offering exposure to preferred stock can still be counted on one hand, this corner of the ETF industry has witnessed tremendous growth as well, as investors have embraced ETFs as a way to gain exposure to this “hybrid” asset class.
At the end of February, the four preferred stock ETFs available to U.S. investors had aggregate assets of about $6.2 billion, up from just $1.7 billion a year ago (when there were only three funds available). While stellar returns have given asset levels a boost, so too have waves of cash inflows into these funds. With interest rates at record lows (and expected to remain there) many traditional fixed income investments are offering minimal yields, leading investors to look elsewhere for current returns. While some have turned to junk bonds and closed-end funds, others have found attractive yields from preferred stock.
Preferred Stock ETFs
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A preferred stock is a security that maintains characteristics of both stocks and bonds. Preferred stock is senior to common stock, but subordinate to debt instruments. Preferred stockholders generally do not maintain voting rights, but often come before common stockholders when it comes to dividends or liquidation payments. While some preferred stock features a convertibility feature that allows holders to ultimately redeem shares for common stock, most preferred shareholders maintain no voting rights.
Because they are junior to debt, shares of preferred stock were hammered during the recent downturn, as investors worried that dividends owed would be delayed as companies burned through cash (if issuers of preferred stock didn’t go bankrupt first). Between September 2008 and the bear market lows in March of the following year, the iShares S&P U.S. Preferred Stock Index Fund (NYSEARCA:PFF) lost nearly 60% of its value. Since then, however, PFF has gained more than 180%. Many preferred stock ETFs are now well above their pre-recession highs, a claim very few equity ETFs can make (SPY, for example, is still about 5% below levels touched in September 2008).
Despite a recent pullback, preferred stock ETFs have continued to climb higher in 2010 as yield-hungry investors have become more comfortable with alternative investment options. PFF was recently offering a 30-day SEC yield of about 6.6%, compared to just for 1.8% AGG and 4.7% for LQD.
Preferred Stock ETF Options
For investors considering an investment in preferred stock ETFs, there are a number of options available:
- SPDR Wells Fargo Preferred Stock ETF (NYSEARCA:PSK): The newest preferred stock (it launched in September 2009), this ETF tracks the performance of the Wells Fargo Hybrid and Preferred Securities Aggregate Index. This benchmark offers impressive depth of exposure, counting more than 170 individual securities among its components.
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- iShares S&P U.S. Preferred Stock Index Fund (PFF): With more than $3.5 billion in assets and average daily volume of nearly 1 million shares, PFF is the largest and most liquid preferred stock ETF. PFF tracks the performance of the S&P U.S. Preferred Stock Index, a benchmark that includes exposure to a number of industries but is tilted heavily towards financials.
- PowerShares Financial Preferred Stock Portfolio (NYSEARCA:PGF): While most preferred stock funds are dominated by securities issued by financial companies, this ETF focuses exclusively on the financial sector. PGF tracks the Wachovia Hybrid & Preferred Securities Financial Index, a benchmark that includes about 30 securities selected by Wachovia pursuant to a proprietary methodology. PowerShares also offers the Preferred Portfolio (NYSEARCA:PGX), a fund that maintains minor allocations to non-financial sectors.
Disclosure: No positions at time of writing.