Don't Buy Preferred ETFs, Build Your Own

Includes: PFF, PGF, PGX
by: Kraken

ETFs have truly revolutionized the securities industry. It's great to have the ability to purchase a basket of securities that you can easily liquidate if necessary. ETFs have definitely disrupted the mutual fund industry as more and more investors invest in different baskets. There are ETFs for several different industries including fishing and social media.

While ETFs are great products, if investors are active in the market and want to avoid paying fees, it can be better to build your own basket of ETFs. As an income investor, I want to grab as much yield as I can. It's great to see dividends flowing into your account, but if you're buying an ETF, the fees will eat into your yield. So sometimes it's much better to avoid the large ETFs. In addition to this, you get to diversify your portfolio how you want.

The three major ETFs for preferreds are:

iShares US Preferred Stock Index (NYSEARCA:PFF)

PowerShares Preferred (NYSEARCA:PGX)

PowerShares Financial Preferred (NYSEARCA:PGF)

Let's take a look at what the yields are on these ETFs.

ETF Yield
PFF 5.79%
PGX 6.72%
PGF 6.65%

The yields for these ETFs range from the mid 5s to the high 6s. It's important to note that PGX has the highest yield due to its concentration on financial preferreds. The industry is more volatile than others, which justifies its higher yield.

Here are a few reasons why I don't like these ETFs:

  • No control over investments
  • Proceeds from called preferreds could be used on lower yield investments
  • Fees

Just like most ETFs, investors have no control over the underlying investments. Now this is fine if you simply don't have the time to perform due diligence on preferreds, but for those that do, this could be a costly mistake as I will explain in further detail.

Remember, that these ETFs are holding preferreds, which are callable after a certain period of time. So let's say XYZ series A preferred has a yield of 8%. If the series A is now past its call date, the company could issue a new preferred with a lower yield. Essentially similar to refinancing debt at a lower rate. In the case of these ETFs, they would rotate those extra funds back into the new issue. This would hurt the ETF price as the yield would decline.

The last problem with these ETFs is the fees. The fees vary from .48% to .64%. As an income investor, I desire to maximize the dividend payments for the amount of risk I am taking on. These fees cut into those returns. Investors can avoid these fees by simply doing their own due diligence regarding certain issuances.

Preferred ETFs are not a bad investment, but for those that can commit a small amount of time each week to do some proper research, you can save money and maximize yield. You can also diversify your portfolio based on your risk parameters.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.