PowerShares' Preferred Stock ETF Just Doesn't Stack Up

PowerShares Financial Preferred Portfolio (PGF) is a new ETF that happily addresses the need to capture Preferred Shares in ETF format. Unfortunately, It doesn't do it as well as it could.

Using the information available on their website (particularly the full roster of holdings), I fetched for each holding its annual coupon rate, credit rating (both figures accessible through the excellent, and free QuantomOnline.com) and last closing price (Dec. 4, through Yahoo! Finance). My goal was to come up with a weighted average yield for the fund, as well as its overall credit quality.

The end result is this: PGF's holdings sport a weighted average yield of 6.31%. After subtracting the 0.6% expense ratio, this should amount to 5.71% annual distribution, or yield to fund shareholders. The credit quality ranges from BBB- to A+, and on aggregate is just about A or A-.

The $64,000 question is of course: How does this compare with the alternatives -- Closed-end funds like Flaherty & Crumrine/Claymore Preferred (FFC), John Hancock Pref. Income Fund (HPF) and Blackrock Prefered Opportunity Trust (BPP)? The answer is: not too favorably, for the following reasons:

• It's not adequately diversified. It holds only 24 issues (even though they say "approximately 30" on the fund page), and even that is misleading: They hold multiple series of the same issuers (4 from dutch giant ING, 3 from Aegon), which means one default could really hurt. I can't understand why Powershares chose this particular Wachovia index to track, when they could have easily picked one of the broader ones. They've licensed the entire family.
• It doesn't yield much, when you compare it to the CEF's available. Granted, it does have better credit quality, but not by much. The BPP fund, for example, despite it's 1.26% expense ratio and 6% premium, still yields 7.59% - a lot more than PGF.
• It holds exclusively fixed rate preferred. The exclusion of Floating rates is baffling, given that investors are looking for a broad index, not a particular theme.

Personally I'll stick to the CEF's for now. But I will also await a broader index ETF that addresses these concerns.

Full Disclosure: Author is long FFC

Comments

[JonD]

ever heard of "leverage"?

[Tim Moore]

I see you own FFC which I plotted over 5 years against the S&P500 and it has performed terribly. I assume that is because I am not getting a chart which is total return including yield? Where do you go to plot/compare the total return on say a Vanguard Dividend Fund versus FFC?

Best wishes

Tim

[Josh Betts]

As an employee and portfolio consultant for PowerShares I felt the need to express a couple other thoughts on this comparison for it to be fair.

An important factor that needs to be considered when evaluating securities is their tax consequences. Roughly ½ of fund investments reside in a qualified account, however, this still leaves the other ½ vunerable to inefficient tax managed funds. It should be noted that when comparing the yields of closed-end funds to the PowerShares Financial Preferred Portfolio (ticker PGF), one of the main filters in determining which securities are eligible for inclusion in the fund is that the dividends paid by the preferred stocks must be 100% qualified dividend income eligible. This significantly improves the after-tax yield of PGF in a taxable account, which is what investors are ultimately concerned with, as this is how much ends up in their pocket. Also, while closed-end funds can offer some upside appreciation potential when purchased at a discount, they are also subject to the risk of trading at an even greater discount to their NAV. Exchange-traded funds however, tend to trade at or near their NAV prices as specialist are able to create and redeem shares with the fund in larger blocks of 100,000 shares. This helps to address the supply/demand of shares and helps ETFs to trade much tighter to their NAVs.