by Kyle Woodley | July 17, 2012 4:30 am
Remember risk appetite? I sure don’t. For months, investors have been cringing at worrisome headlines from home and across both ponds and fleeing into an assortment of yieldy defenses, be it dividend stocks, MLPs, REITs, bonds … you name it.
Another way investors have gotten their income jollies is preferred stocks. Commonly also referred to as stock-bond hybrids, they’re issued and traded just like common stock, but they often pay much higher dividends than common stock and offer a little protection. Should trouble set in, a company must axe the common-stock dividends before it touches the preferreds’.
So, the timing sounds ripe for Global X’s newest product, the Global X SuperIncome Preferred ETF (NYSE:SPFF) an exchange-traded fund launching today that will bundle about 50 such securities to give investors a broad exposure to this high-yield corner of the world.
The SPFF tracks the S&P Enhanced Yield North American Preferred Stock Index, which comprises the highest-yielding preferred securities listed in the U.S. and Canada. Securities must be at least $250 million in market cap and have a three-month average daily value of $1 million, and dividends are paid out monthly.
So, what kind of yield are we talking about?
Well, Warren Buffett previously has made headlines for landing sweet preferred-stock deals, such as 10% dividends for General Electric (NYSE:GE) and Goldman Sachs (NYSE:GS). Of course, companies are going to be a bit more generous when Berkshire Hathaway (NYSE:BRK.B) gets involved. Still, it’s not uncommon to see preferred stock yields around 9%.
But a better gauge for SPFF might be the big dog of preferred stock ETFs, the iShares S&P U.S. Preferred Stock Index Fund (NYSE:PFF). PFF’s baseline index yielded about 7% as of the end of May, while SPFF’s yielded about 7.5%, according to S&P. So, it’s reasonable to think Global X’s fund can achieve a similar yield as PFF (which currently yields 6%), if not more.
However, that 6% yield isn’t in a bubble — investors in the real world have a few risks to deal with.
For one, while preferred stocks’ dividends are more protected than those of common stock, they’re not bulletproof. Amid the financial crisis, Citigroup (NYSE:C) in 2009 not only slashed its common-stock dividend to a nominal penny per share, but it also temporarily suspended the dividend on preferred shares (though it did offer to exchange preferred shares for common stock).
Technically, the safest income in corporations comes through corporate bonds, which have legal obligations for repayment.
Also worth pointing out is something Global X touts as a possible benefit in its press release:
“Like equity, preferred shares trade on an exchange and have the potential to appreciate in value, offering additional income growth potential for investors.”
Click to EnlargeWhile true, that potential is subdued. Take a look at this chart comparing JPMorgan Chase (NYSE:JPM) and its N-Series preferred shares. JPM’s N shares are in black, while JPM shares are in yellow. This kind of lethargy is common for preferreds.
You can get a little more movement out of preferred ETFs themselves. iShares’ PFF fund is up about 10% year-to-date, slightly better than the SPDR S&P 500 ETF (NYSE:SPY). But backing it out a couple years, the much calmer PFF has averaged 3% gains since this point in 2010 vs. 27% returns for the SPDR ETF — and that’s not counting SPY’s own 2% dividend. A more risk-hungry market and higher Treasury yields could end up shaking a few investors from the preferred trees.
And, as is common for preferred-stock ETF funds, SPFF is heavily weighted (75%) in financials. Global X CEO Bruno del Ama chalked this up to the lower valuations across the sector, which necessarily would drive up yields. Still, investors can’t be blamed for being a little leery … just realize you’ll get that kind of exposure for pretty much any preferred-stock ETF you dive into.
As far as SPFF itself, its heaviest weightings go to preferred shares of Credit Suisse (NYSE:CS), American International Group (NYSE:AIG) and Dutch insurance firm Aegon (NYSE:AEG).
And concerning fees: SPFF will charge 0.58%. At 10 basis points higher than PFF, it’s enough to worth noting, but little enough for any significant difference in performance to overcome.
In an interview Monday, Global X research analyst Alex Ashby told me: “We recommend diversifying your income sources and getting different type of exposure to different types of asset classes.”
I couldn’t agree more.
SPFF is a relatively inexpensive way to access one set of high-yielding securities, and the monthly distributions don’t hurt. But this is an income play, through and through, with seemingly limited room for appreciation. And considering it’s possible to have your cake and eat it too — tobacco company Reynolds American (NYSE:RAI) yields 5% and has gained almost 25% in just a year — there’s no reason to push all of your chips into anything that doesn’t offer both growth and income.
Still, preferred stocks do offer some stable income, so they’re worth considering as a part of a balanced portfolio. Just keep an eye on the market and those T-notes for any signs of life.
Kyle Woodley is the assistant editor of InvestorPlace.com. As of this writing, he did not hold a position in any of the aforementioned securities. Follow him on Twitter at @KyleWoodley.
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