A Preferred ETF Takes A Tumble

| About: PowerShares Financial (PGF)

Summary

Preferred stocks and ETFs had a rough November.

Besides interest rates, PGF has other factors causing drag.

Another preferred holding, WFC-L, has done much better this year.

Preferred stocks, which despite their name have more in common with bonds, had a rough November.

The Trump effect--the post-election expectation of fiscal stimulus next year--has caused a massive rotation, raising prices of cyclical and financial stocks while depressing fixed-income.

The preferred portion of my portfolio took a beating, causing me to take another look at my holdings.

The PowerShares Financial Preferred Portfolio ETF (NYSEARCA:PGF) is an fund I had held for several years as a way of diversifying my preferred stock holdings (Quantum description).

It has a four-star Morningstar rating and had been performing well for several years, with a five-year return of 8.6%. But it began weakening in September after interest rates bottomed over the summer, and then the wheels came off after the election, with the price falling 4.7% in November.

PGF Chart

PGF data by YCharts

Here is a description of the fund:

The investment seeks investment results that generally correspond (before fees and expenses) to the price and yield of the Wells Fargo® Hybrid & Preferred Securities Financial Index. The fund generally will invest at least 90% of its total assets in preferred securities of financial institutions that comprise the underlying index. The underlying index is a market capitalization weighted index designed to track the performance of preferred securities traded in the U.S. market by financial institutions."

Expenses are a bit higher than other preferred ETFs, but not awful:

Annual Fund Operating Expenses
(expenses that you pay each year as a percentage of the value
of your investment)
Management Fees 0.50%
Other Expenses 0.13%
Total Annual Fund Operating Expenses 0.63%

Source: PowerShares prospectus

I plugged PGF into a spreadsheet to see how an investment at last year's closing price looks compared to my largest holding, Wells Fargo (NYSE:WFC) series L convertible preferred, which I've written about several times. (Since WFC-L has gone ex-dividend, I included the payment on December 15 in the calculation.)

PGF 1000 shares WFC-L 20 shares
1/1/2016 -18830 1/1/2016 -23750
1/30/2016 89.7
2/28/2016 88.3
3/31/2016 91.4 3/15/2016 375
4/30/2016 92.5
5/31/2016 92.5
6/30/2016 86.7 6/15/2016 375
7/31/2016 87.6
8/31/2016 84.9
9/30/2016 84.3 9/15/2016 375
10/31/2016 83.8
11/30/2016 84.3 12/15/2016 375
11/30/2016 18020 11/30/2016 24047
XIRR 0.009278 0.084911

Wow, look at that difference. Even though it got crushed in November (down 7.9%, WFC-L is still up 8.5% for the year on a total return basis, compared with just 0.9% for PGF. (WFC-L trades like a long-dated bond because the conversion feature is very unlikely to be triggered).

Why such a large difference? Several factors are involved.

  • Even though as an ETF it has relatively low expenses, PGF's return is lowered by its expense ratio, 0.63%, which owning the individual security avoids.
  • PGF's yield-on-cost for the year will wind up about 5.5% (adding all the dividends and dividing by the opening price). By the same measure, WFC-L yielded 6.3%.
  • WFC-L has appreciated 1% during the year on a price-only basis despite the Trump tantrum, possibly as the result of more investors wanting a 6 percent yield with little call or credit risk. PGF has gone down 4.5% on a price-only basis. It now sells at a slight discount (0.17%) to its net asset value.

Source: Charles Schwab

Conclusion: I decided to sell my PGF, believing it's not a great value in a strong-dollar, rising-rate environment and I prefer to own individual investment-grade securities where the risk is largely confined to interest rates.

Disclosure: I am/we are long WFC-L.

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.

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