Preferred stock is a great tool for income investors who are looking for dividends but are leery of the bond market.
After all, it’s almost certain the Federal Reserve will raise rates in the next year or so, given the modest pace of inflation and the continued downward march in the unemployment rate. And if rates rise, bonds could take a hit — but preferred stock could remain insulated thanks to its high yield.
Preferred stock is considered by many to be halfway between a bond and a stock. It is similar to a bond in that preferred stock has low volatility and (usually) a fixed rate. Meanwhile, preferred stock is similar to common stock in that it still comes after bondholders and debt obligations in the event of bankruptcy, and while less volatile than common stock, it does have the ability to move up (or down) on a share-price basis over time.
If you’re interested in using preferred stock as a way to find big income, here are five funds that focus on preferred shares that will give you 5% yields or better:
iShares U.S. Preferred Stock ETF (PFF)
One of the big dogs in the space is the iShares U.S. Preferred Stock ETF (PFF), which boasts $10.5 billion in assets and a seven-year track record. Other preferred funds are significantly smaller and have a relatively brief tenure on the market, so investors can take comfort in the standing of PFF vs. its peers.
The big knock on PFF is that it’s overweight in preferred stock of financial companies — almost three-quarters of its assets are in banks and other financial service companies such as insurers. So be aware of this: Even if preferred stock is less volatile than common stock, there still is a risk that trouble for the financial sector could weigh on this fund, too.
But it’s a double-edged sword, too. The rally for the financial sector recently has resulted in a big pop for PFF on a per-share basis, with the fund actually outperforming the S&P 500 slightly year-to-date in addition to delivering a mammoth 5.7% yield. Meanwhile, PFF charges 0.47%, or $47 for every $10,000 invested, in expenses.
If you’re not afraid of getting overweight in banks, then consider PFF as an income investment.
Global X SuperIncome Preferred ETF (SPFF)
Among the preferred stock ETF crowd, the Global X SuperIncome Preferred ETF (SPFF) is among the very top payers. Its dividend yield is a juicy 7% right now, which is almost three times the yield on 10-year Treasuries.
The Global X preferred stock fund offers monthly distributions to boot, making it a powerful income investment for long-term investors.
SPFF is even more heavily weighted in financials than PFF, with more than 90% of total assets in this sector, and charges 0.58% in expenses.
Nuveen Preferred Securities Fund (NPSAX)
Top Holdings: Financial Security Assurance, GE Capital, Catlin Insurance Co.
The Nuveen Preferred Securities Fund (NPSAX) differs from PFF in a few ways.
For starters, it’s a traditional mutual fund instead of an ETF … though, for the record, the long-term nature of preferred stock investing for income means this shouldn’t matter to you. But most importantly, NPSAX is even more heavily invested in financials with 58% in banks — and another 32% in insurance and 4% in financial services. That’s more than 90% of the entire portfolio!
The fees are a bit steep, too, at 1.07% in annual expenses plus a maximum 4.75% sales charge. NPSAX has a total return on paper of 8.5% year-to-date … but actually has only delivered 3.4% gains when you back out all the possible sales charges.
But all that aside, you can’t argue with long-term performance and experienced management. NPSAX’s portfolio managers have 26 years of combined experience, and since its inception in 2006 has regularly ranked at the top of the class among peer funds in its category.
The fund seems to have a knack for off-the-beaten path financials, including companies that trade in preferred stock but not any common stock. This allows income investors a way to gain exposure to financial companies they literally couldn’t invest in otherwise.
Market Vectors Preferred Securities ex-Financials (PFXF)
If you don’t like the financial focus of these other funds, there’s always the Market Vectors Preferred Securities ex-Financials (PFXF), which steers clear of banks altogether. The fund is heavily focused on REITs, telecoms and utilities instead, providing a much more stable base of preferred stocks — and ones that most income investors are already comfortable with.
The red flag in this fund, to me, is that the Market Vectors fund only opened up shop in July 2012 — partially because of the fashionable nature of preferred stock and the distaste for banks thanks to the financial crisis. I’m always skeptical of fad investments, and it seems like PFXF was made-to-order based on tastes of the day.
Still, the performance is good as of late. The fund is up more than 10% in 2014 to outperform the S&P and offers a hefty yield.
PFXF charges 0.4% in expenses.
PowerShares Preferred Portfolio (PGX)
Another bank-heavy preferred stock fund is the PowerShares Preferred Portfolio (PGX). This fund is 88% allocated in financials, with a smattering of utilities and telecoms throughout the portfolio to round it out.
Still, you can’t argue with the yield, with a 6.1% rate currently. You also can’t argue with 9% gains year-to-date in 2014 to outperform the S&P 500.
The PGX fund is older than some of the other instruments out there, born in February 2008 just in time for the market meltdown, but since late 2009, the fund has been very consistent as an income-generator for its investors.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. As of this writing, he did not hold a position in any of the aforementioned securities. Write him at email@example.com or follow him on Twitter via @JeffReevesIP.