Preferred Stocks for Income: Buy Individual Issues or ETFs?

| About: PowerShares Preferred (PGX)
This article is now exclusive for PRO subscribers.

Yesterday I accepted an invitation to speak at the Inside ETFs Conference in February put on by IndexUniverse. They sent along a tentative agenda for the conference and asked me to pick a panel or two that I'd be interested in. Third or fourth on my list (so I doubt I will be in this one) is one titled Do ETFs Work for Fixed Income?

In past posts I've talked about picking the best (obviously this is subjective) tool to capture whatever it is that is being sought. It does not make sense that any single wrapper can be the best for all segments of all markets. Portfolios that only use ETFs are missing out on all sorts of things.

This point is very true with fixed income investing. There are four wrappers for fixed income, that is without getting in to UITs or other untradedable products: individual issues (including preferreds), ETFs, closed end funds and traditional mutual funds, and we have all four in our ownership universe. I think the best path here is an agnostic one. Investors should choose the best product for each exposure they want given the totality of their situation.

From the top down foreign fixed income exposure is important for most folks, in my opinion. We do a fair bit with individual sovereign issues. Generically speaking this is a great way to go but not right for everyone due in some cases to account size, so ETFs and CEFs can work; for some people they are the better way to go.

I have not been a fan of preferred stock ETFs. When they first came out I wrote about them negatively for theStreet. Back then they were obviously very heavy in financial companies because that is who issues most of the preferreds but these funds had a lot of exposure to what I felt were crappy companies. There was a foreign preferred ETF, that might be gone now, that had multiple issues from banks that are no longer with us. The PowerShares Preferred Portfolio (NYSEARCA:PGX) was issued around $20, bottomed out in the sixes and closed yesterday at $14.54. The two individual preferreds we use the most have each been reasonably close to par for a long time since the meltdown and are now back at par whereas PGX still needs to go up 33% to get back to par--that is if thinking of $20 as par is reasonable.

That is not to say what we use did not go down because it did but it did not take a lot of work to look under the hood, see companies making the most headlines being featured in the funds and deciding to stay away. Here the ETF wrapper was helpful because anyone looking could know exactly what the funds held and could make an informed decision but this is not the case with traditional bond mutual funds. The reported holdings lag by three- six months so buying an actively managed bond fund boils down to a leap of faith that the manager will avoid the sludge. Some managers did and some did not.

Contrast my opinion with any of the many articles out there that look favorably on the preferred stock ETFs. Clearly anyone who bought in the sixes got a fantastic entry point and picked up some yield along the way too. I'm not sure what it is but there is a bullish case for these ETFs now so this boils down to what is sought after in the fixed income portion of the portfolio. Personally I want as little volatility as possible, take in a little yield and have some protection in case the dollar does get away.

What I want is not going to be suitable for everyone. Each person has to understand what they want out their fixed income portfolio and build accordingly using whatever products they feel are most consistent with their intention. This is done by thoroughly understanding the pluses and minuses of each product.

Disclosure: None