Since the start of this year, investors have been treated to a heaping dose of speculation regarding what the Federal Reserve’s next move on interest rates will be.
As a result, investors have also had to endure the impact of all that speculation on scores of income-generating, rate-sensitive asset classes.
Previously beloved asset classes such as master limited partnerships, high-yield corporate bonds, real estate investment trusts and the utilities sector, along with the corresponding exchange-traded funds, have all been pinched by the notion the Fed will soon increase borrowing costs.
Add preferred stocks and preferred stock ETFs to that list.
Preferred stocks are often viewed as hybrid securities, meaning market participants view preferred stocks as part equity, part bond. Preferred stocks are often prized by astute income investors because preferred stock dividends are fixed; it is a significantly negative financial event when a company skips out on paying preferred dividends; and the asset class features tempting yields.
Additionally, shareholders of preferred stock rank higher in the pecking order than common shareholders and are more likely to recoup some money in the event of issuer default or bankruptcy.
However, given the asset class’s sensitivity to interest rates, it is not a stretch to say the market views preferred stocks and preferred stock ETFs more as fixed income than equity instruments.
That’s fine, just as long as the Fed does not raise rates.
With that in mind and with scores of market pundits betting the Fed has missed its window to increase borrowing costs, now might be a good time to revisit preferred stock ETFs.
Preferred Stock ETFs — PowerShares Variable Rate Preferred Portfolio (VRP)
Expenses: 0.5% per year, or $50 for every $10,000 invested
Of the preferred stock ETFs on the market today, only one is designed to endure a rising rate environment: The PowerShares Variable Rate Preferred Portfolio (VRP).
VRP follows the Wells Fargo Hybrid and Preferred Securities Floating and Variable Rate Index. Notice two important terms there — “floating” and “variable rate.”
Due to the fact that VRP’s 95 holdings are not fixed-rate securities, these preferred stocks are not nearly as vulnerable to a hawkish Fed as are traditional preferred stocks.
“Debt securities with floating or variable rates may help protect investors from a rising rate environment. Even if maturities extend beyond a call date, interest rate risk can be much lower and is limited to the time until the next rate reset,” according to a research note from PowerShares.
Typically when investors embrace securities that are not highly vulnerable to rising interest rates, the trade-off comes in the form of a lower yield. That is not the case with this preferred stock ETF, as the $355.1 million VRP has a 30-day SEC yield of 5.2%.
Preferred Stock ETFs — Market Vectors Preferred Securities ex Financials ETF (PFXF)
The Market Vectors Preferred Securities ex Financials ETF (PFXF) is one of the most unique spins on the usual tried-and-true preferred stock ETF for one simple reason. As the ETF’s name implies, it excludes preferred stocks issued by financial services firms, a rarity in the preferred stock ETF space because a significant percentage of preferred issuance in the U.S. comes by way of financial services companies.
PFXF’s exclusion of financials has its perks. This preferred stock ETF’s “index excludes traditional financial companies which have been more volatile than other sectors in recent years,” according to Market Vectors.
To be clear, PFXF excludes preferred stock issued by banks. The ETF allocates nearly 34% of its weight to REITs, with another 20.3% devoted to preferred stock issued by utilities.
The $254 million PFXF has a 30-day SEC yield of 6.6% and an annual fee of 0.4%. That is paltry in the world of preferred stock ETFs.
“PFXF currently has the lowest published net expense ratio of U.S.-listed ETFs that invest primarily in preferred securities (based on 9 ETFs as of 08/31/15),” according to Market Vectors.
Preferred Stock ETFs — iShares U.S. Preferred Stock ETF (PFF)
Home to over $13.4 billion in assets under management, the iShares U.S. Preferred Stock ETF (PFF) is the big kahuna of the preferred stock ETF space, controlling nearly two-thirds of the arena’s assets. While the aforementioned VRP and PFXF aren’t your grandfather’s preferred stock ETF, PFF is, in fact, your grandfather’s preferred stock ETF.
PFF has a deep bench, as it is home to over 292 preferred stocks, and that bench is well distributed — none of the fund’s holdings command a weight north of 3%.
Well-known issuers found in PFF include Allergan (AGN) and HSBC (HSBC). Since it is prosaic as far as preferred stock ETFs are concerned, PFF devotes almost 40% of its weight to bank stocks, with another 19.7% going to brokerage houses.
To its credit, PFF has navigated the rising rates speculation with aplomb, falling just 1.9% year-to-date.
This preferred stock ETF has a 30-day SEC yield of 5.4%, according to issuer data.
As of this writing, Todd Shriber did not hold a position in any of the aforementioned securities.