Remember the time when the Federal Reserve was not raising interest rates? Those were the glory days for preferred stock funds. Yield-starved investors flocked to preferred stock funds in search of additional income.
That rotation was made easier by the Fed’s relaxed monetary policies, but as is the case with other high-yielding asset classes, preferred stock funds can be vulnerable to rising interest rates. Good news for income investors: some of the perceived vulnerability of preferred stock funds in rising rate environments is just that: perceived.
The iShares U.S. Preferred Stock ETF (NASDAQ:PFF), the largest preferred stock exchange-traded fund (ETF), gained 8.1% in 2017 even as the Fed raised rates three times. Year-to-date, PFF is up just over 2% despite two Fed rate hikes.
PFF is home to $16.87 billion in assets under management, so it can be a good tell regarding income investors’ sentiment toward preferred stock funds. Year-to-date, investors have pulled nearly $743 million from PFF, but that does not mean preferred stock funds should fall off income investors’ radars. Here are five preferred stock funds to consider.
Preferred Stock Funds: Invesco Variable Rate Preferred ETF (VRP)
Expense Ratio: 0.5% per year, or $50 on a $10,000 investment.
For income investors concerned about interest rate risk, the Invesco Variable Rate Preferred ETF (NYSEARCA:VRP) is one of the best ideas among preferred stock funds because this ETF is specifically designed to guard against rate risk.
VRP, which recently turned four years old, tracks the Wells Fargo Hybrid and Preferred Securities Floating and Variable Rate Index. This preferred stock fund was certainly well-timed as the Fed started boosted borrowing costs soon after VRP’s debut, giving investors the opportunity to test the fund’s mettle in rising rate environments.
This preferred stock fund is delivering for investors. Over the past three years, VRP has outpaced PFF by 220 basis points while being 160 basis points less volatile. Although it guards against rate risk, VRP has a 30-day SEC yield of 4.2%.
Preferred Stock Funds: First Trust Preferred Securities and Income ETF (FPE)
Expense Ratio: 0.85%
Many preferred stock funds are index funds, meaning these products are passively managed, but the First Trust Preferred Securities and Income ETF (NYSEARCA:FPE) brings active management to an asset class that could benefit from that methodology in a rising rate environment.
FPE’s annual fee of 0.85% is high relative to passively managed preferred stock funds, but the First Trust fund’s fee is warranted. This preferred stock fund is over five years old, giving it a lengthy track record desired by some advisors and investors. Over the past three years, it has been one of the best-performing preferred stock funds on the market, beating some of the funds mentioned here.
Additionally, active management helps FPE offer exposure to less rate-sensitive assets. Over 70% of FPE’s holdings are fixed-rate securities that can transition to floating or variable securities and another almost 14% of the fund’s holdings are floating-rate notes, which are significantly less vulnerable to rising Treasury yields than fixed rate bonds.
FPE has a 30-day SEC yield of 6.6%, underscoring some credit risk in the portfolio. About 47% of FPE’s 238 holdings carry junk ratings or are not rated.
Preferred Stock Funds: iShares International Preferred Stock ETF (IPFF)
Expense Ratio: 0.55%
The benefits of preferred stocks are not confined to the U.S., as highlighted by the iShares International Preferred Stock ETF (CBOE:IPFF). This preferred stock fund holds 113 preferred issues and tracks the S&P International Preferred Stock Index.
This preferred stock fund offers some international diversity, though not much away from North America as Canada accounts for 81.7% of IPFF’s geographic weight. With just over $70 million in assets under management, IPFF often goes overlooked in the preferred stock fund conversation, but give this fund some credit because it has been the best performer of the ETFs mentioned here over the past 24 months.
Be advised IPFF is more volatile than domestic preferred stock funds. IPFF’s three-year standard deviation is more than 1,100 basis points higher than PFF’s.
Preferred Stock Funds: Global X SuperIncome Preferred ETF (SPFF)
Expense Ratio: 0.58%
This preferred stock is a treat for yield-starved investors, as highlighted by a 12-month dividend yield of 7.3%, but that does introduce some risk into the equation. The Global X SuperIncome Preferred ETF (NYSEARCA:SPFF) has traded modestly lower this year, but the ETF is closing in on its 200-day moving average, potentially giving investors a price area to target for entry.
Among preferred stock funds, SPFF is concentrated because its selection universe is limited to the 50 highest-yielding Canadian and U.S. preferred issues. Nearly 48% of the fund’s holdings carry non-investment-grade ratings.
Preferred Stock Funds: Cohen & Steers Preferred Securities and Income Fund (CPXIX)
Expense Ratio: 1.18%
The share class of the Cohen & Steers Preferred Securities and Income Fund (MUTF:CPXIX) featured here requires a massive $100,000 minimum investment, but there are other more approachable share classes of this preferred stock fund.
Over the past five years, this is the best-performing preferred stock fund, according to Morningstar data. That explains the five-star Morningstar for the Cohen & Steers Preferred Securities and Income Fund.
“The investment objective of the Fund is to seek total return through high current income and capital appreciation by investing in preferred and debt securities issued by U.S. and non-U.S. companies. Preferred securities are issued by banks, insurance companies, REITs and other diversified financials as well as utility, energy, pipeline and telecommunications companies,” according to Cohen & Steers.
Todd Shriber does not own any of the aforementioned securities.
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