Last week, Morningstar wrote a terrifically thorough article covering preferred stocks. I would like to tack on a few more interesting in depth points regarding iShares S&P U.S. Preferred Stock Index (PFF).
1. PFF’s price has not moved much over the past year. Its 52 week range is $38.31 - $40.44. By only moving within $2.13 for a volatile year, stability has been proven over time. Now that the stock is sitting at $38.66, it is only $.35 away from its 52 week low which may present a good buying opportunity. However, economic uncertainty may interfere with this approach. Technical analysis junkies will tell you to wait because short and long term moving averages are signaling a downturn.
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2. The majority of risk associated with PFF is its excess of exposure to the financial sector, with over 85% of its holdings. The Morningstar article mentioned that financial institutions use preferreds as instruments in order to increase Tier 1 capital.
Most of the financial holdings of PFF are not exactly preferred stock, however. The financial institutions issued something effectively similar but not identical to preferred stock called “Trust Preferred Securities.” (In short, an institution creates a wholly owned subsidy, the subsidy issues preferred stock to investors and gives the proceeds to the institution in exchange for debt securities).
By taking an in depth look at these prospectuses, it is important to note a clause that states companies may defer dividends up to 5 years (or “20 consecutive quarters” if you want to be exact). However, there is usually a condition that says if distributions are deferred, the company must cease dividends on its common stock. Also, the institution cannot redeem or repurchase any securities junior to the “TruPS.” However, aside from common stock, not much is junior to Trust Preferred.
3. It is also important to know how much of a specific issue PFF owns. For example, the ETF owns 10% of a company called Citigroup Capital IX, a wholly owned subsidiary of Citigroup, Inc. (NYSE:C). It also owns 9% of Countrywide Capital V, a fully owned subsidiary of Bank of America (NYSE:BAC). If banks know their TruPS will be bought by large ETFs, they may start to carelessly issue more securities with less than favorable terms for investors.
4. The iShares website states that 84.48% of its holdings are in the financial sector. When digging deeper, it looks like the ETF’s largest position is General Motors' (NYSE:GM) preferred stock. The next 20 positions are all financial positions. PFF’s largest position is a non-financial which makes it seem that PFF is dreading looking like a financial sector security and trying to diversify, as opposed to doing what is best of ETF shareholders.
Also, a closer look into the non-financials, shows that 7 of the 250 listed securities are from a company called “General Electric Capital Corporation,” a wholly owned corporation of General Electric (NYSE:GE). According to the GE website, “General Electric Capital Corporation conducts most of GE's financial services operations.” Looking at this reevaluation in data, in addition to not accounting for cash, PFF contains closer to 89% financials, not the stated 84%. (On the bright side, there is not nearly as much financials exposure as FAS.)
Conclusion: When buying securities of an ETF that it is opaque, one must look deeply into the data. The numbers, a little web searching, and some prospectus reading can tell you a lot more than you originally thought.
Disclosure: I am long PFF.