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by JT

Van Eck's newest preferred stock ETF has one notable exception: the financial industry. Seeking better yields, investors have turned to preferred shares to boost returns.

Few investors ignore the financial industry, however. Van Eck intends to leave it out entirely. Following the 2009 financial crisis, financial companies looking for immediate liquidity turned to preferred stock issues to raise capital. Nearly 80% of total preferred stock issuance can be traced back to companies in the financial industry, yet the same companies represented 22% of total common equity market cap during their housing bubble peaks.

Preferred Stock: A Hidden Gem?

Preferred shares are usually issued under special conditions. Warren Buffett is known for his love of financing companies with convertible preferred stock, extending companies a helping hand while negotiating better rewards than the general public would receive. Buffett most recently purchased preferred shares of stock from Bank of America in a sweetheart deal that scored him millions of stock warrants for additional upside.

Preferred stock is situated in between bonds and common stock in the event of default, making preferred stock safer than common shares and often as high-yielding as an average debt issue. The new Van Eck fund will hold a range of high-yielding preferred shares. At launch, the Market Vectors Preferred Securities ex Financials ETF (PFXF) yielded 6.8% per year.

What's in the Fund?

The fund will hold a range of non-financial preferred shares, but it will be most concentrated in REIT preferred stock.

By industry, the fund will hold preferred stocks from:

  • REITs – 31 percent
  • Electric – 26 percent
  • Autos – 12 percent
  • Telecommunications – 8 percent
  • Insurance – 6 percent

The exposure is completely different than that of other index-based preferred share ETFs. The SPDR Wells Fargo Preferred Stock ETF (PSK) holds substantially all of its assets in financial firms – the largest 10 holdings are all preferred shares from banking institutions. The Financial Preferred Portfolio (PGF) makes no mistake of its bias – the fund holds preferred shares from the financial industry only.

Investors should consider mixing and matching the new PFXF (no financial exposure) with PGF (only financial exposure) to find the right balance of banking preferred stock in their portfolios.

Alternative Funds

The Market Vectors Preferred Securities ex Financials ETF PFXF is currently the least expensive preferred stock fund in existence. Van Eck charges investors a tiny .4% management fee compared to rival funds which charge investors up to .6% per year.

Expense ratios are even more important to fixed-income and preferred stock funds due to their lower returns. Due to lower liquidity and less interest from investors, bond funds tend to be more expensive at launch than stock funds. A combination of higher fees and smaller total returns can weigh heavily even on the best of portfolios.

The competing PowerShares Preferred Portfolio (PGX) yields 6.8% while another rival fund, iShares S&P US Preferred Stock Index Fund (PFF) yields roughly 5.6% per year.

The Bottom Line

Van Eck's newest fund gets points for diversification and balance as one of the few funds to avoid the financial industry, which makes up four-fifths of total preferred shares in existence by market value. It also gets a leg up on the competition for fees and expenses, seeing as it is the least expensive and one of the highest-yielding preferred stock ETFs.

I find it difficult to believe that much is lost in excluding banking preferred shares in this new ETF. Most banks operate with very high leverage, with less than perfect balance sheets. In the case of liquidation, a bank's preferred stock holders would likely be wiped out as investment holdings are auctioned off to liquidate the firm. So, without additional upside (the fund matches other ETFs on yield without banking exposure) there really isn't much reason to keep financials in a preferred portfolio. If preferreds aren't the right vehicle for your high yield appetite, consider some alternatives like the new Dividend Dogs ETF, International High Yield or any number of these 80+ high yielding MLPs.

Disclosure: No positions in any ETFs mentioned above.

Source: New Preferred Share Fund Minus The Financials