Preferred stock has come into favor these last few years, partially because other income investments are so disappointing.
The yield on the 10-year T-Note is less than 2.2% right now despite overtures of tighter Federal Reserve policy in 2015, and many old favorites among dividend stock investors aren’t much better. Consider consumer staples stocks The Coca-Cola Co. (KO), Colgate-Palmolive Company (CL) and Procter & Gamble Co. (PG) that all yield less than 3% in dividends right now.
So where is an investor to turn if they want big yield? One alternative is preferred stock, or at least funds that own this asset class.
Preferred stock is, in many respects, a hybrid between common stock and corporate bonds. While not as stable as bonds, preferred shares are not as volatile as common equity and are ahead of common shareholders in the pecking order when it comes to getting paid.
This can give you a bit more yield, but also a bit less risk than some of the alternatives.
Among the preferred stock investments available for small-time investors, here are my three favorites right now that all yield more than 5%:
Global X SuperIncome Preferred ETF (SPFF)
30-Day Yield, Less Expenses: 6.7%
Gross Expense Ratio: 0.58%, or $58 annually for every $10,000 invested
Top Holdings: Wells Fargo & Co. (WFC), ArcelorMittal SA (ADR) (MT), American Realty Capital Properties Inc (ARCP)
Total Assets: $193 million
YTD Returns: –1%
Global X SuperIncome Preferred ETF (SPFF) is one of the smaller preferred stock funds out there, but it is one of the top payers in the space. It yields a juicy 6.7% right now based on the last 30 days of payouts — and an even more impressive 7.5% if you average the last 12 months of payouts. Either way, that’s more than three times the yield you’re getting on 10-year Treasuries.
The Global X preferred stock fund is an income investor’s best friend not just because of the yield, but also because of the monthly distributions that provide regular cash flow.
Just be warned that this fund is heavily weighted in financial stocks. About 75% of assets are in core financial stocks like banks.
While many preferred stock ETFs go big into banks, this one is a bit more overweight than others. Also, diversification within the fund from company to company is also a bit lacking, with the top 10 positions making up more than a third of the entire portfolio for SPFF.
Of course, that’s also how this fund offers up the juicy yield — by taking focused bets on a small number of high-yielding preferred stock investments it expects to do well. Still, there are risks — namely, note that this strategy has SPFF down 1% year-to-date while other preferred stock funds have come closer to tracking the S&P 500.
All this is to say that a lack of diversification is your sacrifice for this big-time yield. If you want big monthly paycheck, however, this might be a trade-off you are willing to make.
Market Vectors Preferred Securities ex-Financials ETF (PFXF)
30-Day Yield, Less Expenses: 6%
Gross Expense Ratio: 0.4%*
Top Holdings: ArcelorMittal SA (ADR) (MT), Tyson Foods, Inc. (TSN), United Technologies Corporation (UTX)
Total Assets: $200 million
YTD Returns: 8%
If you don’t like the financial focus that many preferred stock ETFs offer, there’s always the Market Vectors Preferred Securities ex-Financials (PFXF). As the name implies, this ETF steers clear of banks altogether.
Right now, the biggest sector weightings for PFXF include about 35% of the portfolio’s assets in REITs, 24% in electric utilities and 10% in telecom; a host of other sectors including aerospace and agriculture make up low single-digit percentages of the total portfolio.
Also, unlike other preferred stock funds, the Market Vectors ETF isn’t as top-heavy with its weightings; the top investment of ArcelorMittal makes up just 3.8% of the portfolio, and the top 10 positions only make up about 27% of the total portfolio right now.
It would be naïve to think that this this quirky focus on preferred stock ex-financials doesn’t have its roots in a good marketing strategy, of course. The fund only got off the ground in 2012, and clearly was a response to the mistrust in banks after the financial crisis.
Still, the last year has been pretty good to PFXF with a return that is slightly better than the S&P 500 since Jan. 1 on top of the big monthly distributions.
* Expenses are capped at 0.4% until Sept. 1, 2015.
iShares U.S. Preferred Stock ETF (PFF)
30-Day Yield, Less Expenses: 5.6%
Gross Expense Ratio: 0.47%
Top Holdings: HSBC Holdings plc (ADR) (HBC), Ally Financial Inc. (ALLY), Barclays PLC (ADR) (BCS)
Total Assets: $11.4 billion
YTD Returns: 7%
One of the big dogs in the space is the iShares U.S. Preferred Stock ETF (PFF), which trounces the others in terms of assets under management — and as a result, has the scale to offer small fees.
Full disclosure: I personally own PFF in a taxable account.
PFF is, on the surface, quite overweight in preferred stock of financial companies. Just look at the holdings and you’ll see a laundry list of familiar U.S. bank stocks at the top of the list. But it’s important to note that not a single stock has more than 2.5% weighting in the entire portfolio — and furthermore, that banks, insurance and other diversified financials make up about 64% of the portfolio in total.
So while PFF is indeed leaning toward the banking sector, compared with other funds it’s not that far out of bounds. And remember, the most common place to find preferred stock issues is the financial sector given the naturally capital-intensive nature of banking and lending.
All in all, PFF seems to split the difference between the first two funds. While it does rely pretty heavily on financials, it’s not as overweight as other funds and spreads its assets around the sector nicely. That offers up both a good yield and a good track record for capital appreciation, too.
Just keep in mind that a vehicle like PFF isn’t designed for outperformance, but for income. Shares haven’t budged much at all since 2010, and that’s the way most preferred stock investors like it.
The goal here is to marry the stability of bond funds with the higher dividend yield of preferred equity. And taken in that context, PFF is clearly one of the most popular ways to achieve those goals.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. Write him at firstname.lastname@example.org or follow him on Twitter via @JeffReevesIP. As of this writing, he was long PFF.