Buy These Preferred Stock ETFs For Stability and Income

Includes: C, CNPF, JNK, PFF
by: Helix Investment Research

These days, ETF's have become one of The most popular investment vehicles to trade The markets. From Their humble beginnings in 1989 as a way to track broad market indexes, ETF's have exploded. There is now over $1 trillion invested in ETF's, and in The 22 years since ETF's began, Their range and diversity has increased exponentially. There are now ETF's to invest in nearly anything, from The S&P 500, to oil, to sugar, or even The volatility of The market itself. But we think that over time, investors have lost sight of one of The fundamental reasons for owning ETF's: diversification and income. And The ETF we are highlighting today offers investors both.

In a world where bond yields are at record lows (U.S. bonds of course), investors are starved for yield. While some are driven to high yield "junk bonds" or high-yielding stocks, There are those investors for whom The risk of These asset classes is too great. The solution to this dilemma is preferred stock. While we assume most readers are aware of how preferred stock works, we will quickly review it for readers who may not know. Preferred stock is a class of stock that combines features of both debt and equity. It is senior to common stock, and can be converted to it. While junior to bonds, a company may not pay dividends to common stockholders until all dividends owed to preferred stockholders have been paid. These shares are nonvoting, and are often callable by The corporation. The features of These securities make Them favored by financial companies, for They are an effective way to boost Their capital levels without diluting common stockholders. Preferred stocks carry dividends, which depend on The company's credit rating and operating profile. While it is possible to invest in individual preferred stocks, we think a preferred stock ETF offers investors a better way to invest in this asset class. Most people would immediately think of The iShares S&P Preferred Stock Index Fund (NYSEARCA:PFF) as The ideal way to invest in The sector. With over $7.3 billion in assets, it is The largest preferred stock ETF in The world. With an expense ratio of 0.48% and a yield of over 7%, The fund seems tempting. But a closer look at The ETF's holdings reveals some facts that may trouble risk-averse investors. Over 82% of The fund is in financials, spread amongst various European and U.S. banks. While we are not put off by this exposure to U.S. and European banks, There are some investors who may be. For investors seeking exposure to preferred stock, but with less risk, a brand new ETF has exactly what They are looking for.

The Global X Canada Preferred ETF (NYSEARCA:CNPF) is a new ETF that launched in May 2011, tracking an index of Canadian preferred stocks. While financials make up 77% of this fund, They are a world apart from Their U.S. and European counterparts. Canadian banks were largely unscaThed by The financial crisis, and used it as an opportunity to expand aggressively into The US, all while maintaining strong capital positions. They stayed clear of The disastrous subprime mortgage market, and have been consistently ranked as The safest in The world. As such, There is far less risk in this ETF than its iShares counterpart, which could prove attractive to many investors. The fund has an expense ratio of 0.58%, but its performance over The iShares Preferred ETF show that this 10 basis point increase in expenses can be worth it. Since May, The fund has lost 5.86%, but that does not take into account its monthly dividend distributions. By comparison, The S&P 500 has lost 5.2%, The leading junk bond ETF, SPDR Barclays Capital High Yield Bond (NYSEARCA:JNK) has lost 5.9%, and The iShares S&P Preferred Stock Index Fund has lost over 8%, reflecting its heavy exposure to U.S. and European banks.

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Though The Canada Preferred ETF has a yield that is lower than its iShares counterpart, we think that The increase in stability and lowered risk makes it a worthwhile tradeoff. However, we think investors would be wise to note that The distributions in The iShares ETF have remained steady, a sign that There are no fundamental financial troubles at The firms whose stock The ETF holds. RaTher, its drop in price reflects The markets fears over The health of U.S. and European banks. These fears, while valid, have become overblown. We are long Citigroup (NYSE:C) because we think that These fears are too extreme. But for investors who do not think so, The Canadian Preferred ETF is a great alternative. Below is a table comparing The distributions of The 2 funds since The Canadian ETF began trading, thus providing a clear comparison between The two.

Preferred Stock ETF Distributions

Month iShares S&P Preferred Distribution Closing Price Yield Global X Canada Preferred Distribution Closing Price Yield
July $0.21554 $39.66 0.543% $0.06491 $15.20 0.427%
August $0.21233 $38.70 0.549% $0.04398 $15.42 0.285%
September $0.20732 $37.77 0.549% $0.01978 $14.99 0.132%
October $0.20108 $34.66 0.580% $0.07122 $13.49 0.528%
November $0.20540 $37.31 0.551% $0.04482 $14.28 0.314%

While The Canadian preferred ETF has a smaller yield, its price swings are also much smaller, and it is The better pick for investors who cannot tolerate The wider price swings of its iShares cousin.

Preferred stock is a great investment in a world where investors are hungry for both yield and low risk. Preferred stock is a way for investors to have both. And both of These funds are a great way to invest in this asset class. The fund most suitable for each investors depends on Their risk profile, time horizon, and objective. For us, The iShares S&P Preferred Stock Index Fund is The better choice, because of its higher yield, and we are prepared to accept The higher risk associated with it. For investors who do not want such risks, The Global X Canada Preferred ETF is just as good of an investment, for its lower yield is matched by its lower risk. Which ETF investors choose is a matter of personal opinion. But we think that preferred stock should be The preferred choice of investors searching for a balance between stability and income.

Disclosure: I am long PFF, C.

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