One of the dividend plays that moved from “exotic” to “everyday” in the past few years is preferred stock. Long thought of as a mysterious security that was often illiquid and dangerous, preferred stocks have now become a popular choice for dividend bugs.
That’s because preferred stocks offer the relative security of bonds compared to stocks, move in a tight trading range and offer dividends that are higher than both bonds and dividend stocks.
But even better than preferred stock are the very best exchange-traded funds that combine issuances of preferred stocks into a diversified basket. This provides a backstop should any of the preferred stocks blow up.
Even though such instances are highly unlikely, it’s always better to be safe than sorry. Preferred stocks only blow up when the underlying companies are severely liquidity constrained. And most companies that issue preferred stock are unlikely to be in that position.
With that in mind, here are three of the best ETFs to win big with preferred stock.
Best ETFs for Preferred Stock Dividends: PowerShares Financial Preferred ETF (PGF)
Expenses: 0.63%, or $63 per $10,000 invested annually
Dividend Yield: 5.8%
Preferred stocks do not trade in terribly wide channels, but many of them got whacked in the financial crisis. Nor are capital gains really the goal with preferred stock. Most get issued at $25 per share and can be redeemed at the same price, although some are perpetual.
Still, the PowerShares Financial Preferred ETF (NYSEARCA:PGF) has the best capital gain return over the last five years, up 10.2%. The reason for this relative outperformance is that all of its holdings are in financial stocks , such as Wells Fargo & Co (NYSE:WFC) and JPMorgan Chase & Co. (NYSE:JPM).
That was a good place to be coming off the financial crisis bottom. However, that also means that you aren’t getting as much diversification as you can because you have no sector diversification. Still, if capital gains entice, then you can consider it, along with its 5.8% dividend yield.
Just be aware that a financial shock to the market could be painful.
Best ETFs for Preferred Stock Dividends: VanEck Vectors Preferred Securities Ex Financials ETF (PFXF)
Dividend Yield: 6.2%
In second place for the five-year capital gain return is the VanEck Vectors Preferred Securities Ex Financials ETF (NYSEARCA:PFXF). This is the reverse of the previous selection, in that it eschews all financials in its portfolio. It’s a bit more diversified by sector, though, so that accounts for its 4.13% five-year return.
The basket of stocks consists of 28% real estate investment trusts, 29% utilities, 15% telecom, 4% agriculture, 4% insurance, 4% manufacturing, 3% pipelines, 2% oil & gas, 1% food and 1% healthcare. Some of its top holdings include T-Mobile US Inc (NASDAQ:TMUS) and Exelon Corporation (NYSE:EXC).
There aren’t really any duds in the portfolio, although MLPs have taken a big hit with the energy sector shock over the last two years, but that was offset by the rise in utilities.
There’s another quirk with this ETF, in that the preferred stocks of some REITs sometimes do not get taxed at all. That’s because some companies choose to report the dividends as “return of capital.” It’s impossible to say which REITs will do this or when, but a look at their respective histories will give you a clue.
Best ETFs for Preferred Stock Dividends: iShares International Preferred Stock ETF (IPFF)
Dividend Yield: 6.2%
For those looking for a much greater risk that offers high dividends and the potential for big capital gains, as well as possible losses, look at the iShares International Preferred Stock ETF (NYSEARCA:IPFF). The five-year capital loss on this baby is 38%. The bottom started to drop out in August of 2014.
This preferred stock ETF is largely made of Canadian financial and energy companies, such as Toronto-Dominion Bank (NYSE:TD) and TransCanada Corporation (USA) (NYSE:TRP). Much of the ETF’s woes can be traced to the fact that Canada is rich in resources, but also in a period of commodity price declines. Oil, in particular, has weighed heavily.
Now, the prices of many of these preferred stocks have been blasted. None appear to trade above par and some are below $4 per share. Some have suspended dividend payments for now. Thus, the dividend yield is 6.22%. That’s pretty good, and arguably there is not much further for the index to fall. If that’s to your taste, getting in at around $16 per share on the index could lead to some nice capital gains over time.
Lawrence Meyers is the CEO of PDL Capital, and manager of the forthcoming Liberty Portfolio stock newsletter. As of this writing, he has no position in any stock mentioned. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.