PowerShares Preferred Stock ETF to Compete with iShares Alternative

Investors interested in owning preferred stocks rather than more common share classes through exchange-traded funds [ETFs] have a new option.

The PowerShares Preferred Portfolio (AMEX: PGX) launched on Thursday. It follows last year's debut of the iShares S&P U.S. Preferred Stock Index Fund (AMEX: PFF).

Preferred stocks are a hybrid type of investment vehicle. They hold some of the same characteristics of bonds yet are priced closer to stocks. They're considered senior to common shares in liquidations and bankruptcies. But they're still junior to other forms of corporate debt such as straight bonds.

And unlike shares of common stock, preferred shares don't provide voting rights to their owners.

But in some instances, preferred shares can be converted into common stock. "In those cases, you generally give up a little bit on the yield side, but gain some on the pricing," said Herb Morgan, president of San Diego-based Efficient Market Advisors.

Since hitting the market in April 2007, PFF hasn't proved a huge asset gatherer. Then again, since its inception through year's end, it had returned -14.3%, points out Morgan.

"It launched just in time for the subprime mess and the whole credit meltdown," he said. "Both the iShares and the new PowerShares ETFs are heavily skewed towards financials."

The advantage to preferred stocks is that they include dividend payments. The iShares ETF in November paid out 74 cents per share. But that was a big leap from past months, when it's been closer to the 20 cents per share range.

"The vast majority of preferred stocks are issued by financial companies," Morgan said. "So what people need to understand is that they get a pretty significant exposure to that one sector in both the iShares ETF and the new PowerShares Preferred ETF. They're both in the 75% [of total assets] range in terms of assets devoted to financials."

Names like Citigroup and Wells Fargo, along with some other banks and mortgage-related companies hardest hit by the ongoing credit crunch, are top holdings in both funds, he added.

PGX has an expense ratio of 0.50% per year compared with PFF's 0.48%.

The iShares' top sectors other than financials are metals (9.5%), consumer discretionary (9%) and energy (2.3%). No detailed breakdown was available immediately from PowerShares.

Morgan doesn't own any of either ETFs for his clients. But he says the idea of owning preferred stocks in an ETF format does hold some appeal as another method of diversification.

"Some people might consider it a safer way to invest in the financials sector," he said. "At least you get some yield to help cushion yourself if they don't rebound for awhile. It might be better than investing in a straight common stock financials-heavy fund."

Still, he's not ready to test new waters yet. "It'd be nice to see a preferred ETF that can track a more diversified index of preferred stocks," said Morgan.

Written by Murray Coleman

• Seeking Alpha's ETF Selector