Preferred stock exchange traded funds have become another way for investors to play the yield theme in the uncertain market. As investors search for ways to earn capital on their investments, preferred stocks have become a counterpart for dividend strategies.
However, as Europe’s debt crisis continues to roil markets, investors need to be aware that preferred ETFs have heavy concentrations in the financial sector.
“Preferreds are hybrid securities that have characteristics of both stocks and bonds, and are typically issued by financial institutions, utilities, and telecom firms. They make regular income payments and are rated by the major credit-rating agencies,” Timothy Strauts for Morningstar wrote. [Preferred ETFs Yielding Over 6%, But Come with Risks]
Investors are seeking funds that will help them make a return on their capital, as Treasury yields are historically low. Currently, the yield on a 10-year Treasury bond has been under 1.8%. Preferred shares and ETFs are an interesting choice because they are hybrids that represent both equities and fixed-income.
Preferred shares are classified as shares having a fixed rate of dividend on their face value (par value), Zacks reports. These types of shares generally get preference over equity shares in terms of both dividend payments as well as at the time of liquidation should the firm go belly-up. [Investors Chase Yield with Preferred Stock ETFs]
Preferred stocks are a difficult part of the market to choose stocks from. Since the ETFs pick the companies for investors, a difficult part of the process is done. These stocks are sensitive to interest rate movements and the overall performance of the company issuing them.
The iShares S&P U.S. Preferred Stock Index (PFF - News) is highly concentrated (about 80%) in financial stocks, and most preferred shares issued are from this sector. This is the largest and most liquid preferred shares ETF.
The index uses a modified cap weighting; eligible preferreds must have a capitalization greater then $100 million and have traded over 250,000 shares in the previous six months, according to Morningstar data. PFF yields 6.45%, and charges 0.48%. [Waiting Out the Stock Market with Preferred High Yield ETFs]
Other Preferred Stock ETFs:
- PowerShares Preferred (PGX - News) yields 6.8%
- PowerShares Financial Preferred (PGF - News) yields 6.8%
- SPDR Wells Fargo Preferred Stock (PSK - News) yields 6%
iShares S&P U.S. Preferred Stock Index
Tisha Guerrero contributed to this article.
Full disclosure: Tom Lydon’s clients own PGF.