Count preferred stocks among the asset classes that have become more accessible thanks to exchange-traded funds. In an income-starved world, the iShares U.S. Preferred Stock ETF (NYSEARCA:PFF) is well-positioned and much-loved.
The ETF debuted in the first quarter of 2007. A couple of years later, the U.S. was clawing its way out of the global financial crisis and interest rates started falling across the developed world, leaving income investors scrambling for sources of income and yield beyond government bonds.
That scramble has helped PFF, which yields 5.3% at current prices, claw out more than $18 billion in assets. While this fund has several credible rivals, PFF is by far the biggest ETF invested in preferred stocks.
Tracking the S&P U.S. Preferred Stock Index, PFF is heavily weighted to banks and financial services stocks, with top 10 holdings that include preferreds from the likes of Wells Fargo & Co (NYSE:WFC), Citigroup Inc (NYSE:C) and HSBC Holdings plc (ADR) (NYSE:HSBC). No single holding makes up more than 3% at present.
Looking Closer at Preferreds
Market participants view preferred stocks as a “hybrid” security that’s part-equity, but also part-bond. They trade on exchanges just like common stock, for instance, but they pay out a fixed dividend that’s more similar to a bond coupon.
A nifty feature of preferred dividends — beyond those payouts usually being higher than those delivered to common shareholders — is that they’re paid out before common stock, and a company can’t reduce or suspend the preferred shares’ dividends before first doing so to common stock. Better still, before a company re-instates a dividend, it must first pay out any missed payments on the preferreds.
Preferreds do have some risks, of course.
One of the biggest risks in an owning an ETF like PFF is interest-rate risk. Consider income-generating sectors such as real estate and utilities. These are viewed as bond proxies, and as such, are vulnerable to rising interest rates. Now think about preferreds, which are even more bond-like and don’t have much room for capital appreciation, and thus can suffer when Treasury yields jump.
Such are the breaks of embracing high-yielding assets like preferred stocks.
As of this writing, Todd Shriber did not hold a position in any of the aforementioned securities.