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By Kyle Woodley, Senior Investing Editor | October 14, 2019
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Preferred stocks typically aren’t first, second or even third to mind when investors think about what they want to include in their portfolios.
But if you’re an income hunter and you don’t already have these stocks on their radar, you might want to give them a look.
Preferred stocks are frequently referred to stock-bond “hybrids” because they contain elements of common stock (the type of stock you typically invest in) and bonds. For instance, like common stock, preferreds represent ownership in a company, and they typically trade on exchanges. However, like bonds, preferred stocks typically don’t include any voting rights.
The primary feature of preferred stocks, however, are their dividends. Preferred stock dividends are actually closer to bond coupon payments in nature, in that they’re typically set at a fixed amount. These dividends are high, too, often in the 5%-7% range. Just note that preferred stocks also tend to act more like bonds in that they trade around a par value. So they’re a great source of fixed income, but they’re not going to shoot considerably higher, like common stocks, as a company grows.
While you can easily purchase individual preferred stocks, exchange-traded funds (ETFs) allow you to reduce your risk by investing in baskets of preferreds. That helps to prevent any single preferred-stock disaster from undermining your portfolio.
With that in mind, here are three preferred stock ETFs to buy.
Data is as of Oct. 13. SEC yield reflects the interest earned for the most recent 30-day period after deducting fund expenses. SEC yield is a standard measure for preferred-stock funds.
Market value: $16.5 billion
SEC yield: 4.9%
Expenses: 0.46%, or $46 annually on a $10,000 investment
The iShares Preferred and Income Securities ETF (PFF, $37.36) is the largest, most liquid preferred stock ETF on the market. At $16.5 billion in assets under management (AUM), it’s roughly thrice the size as its second-biggest competitor, Invesco Preferred ETF (PGX). It’s also cheaper than PGX by 6 basis points (a basis point is one one-hundredth of a percentage point).
PFF is as straightforward as it gets, and many (though not all) competitors are built in a similar fashion.
The ETF invests in 480 different preferred stocks, almost entirely from U.S.-based companies. The lion’s share of PFF’s preferreds come from financial-sector firms such as Wells Fargo (WFC) and Citigroup (C). Add up preferred stocks from banks (28.2%), diversified financials (20.4%) and insurers (10.7%), and you get a roughly 60% sector weight. Another 11.4% of the preferreds come from real estate investment trusts (REITs), which used to be part of the financial sector until 2016, when the Global Industry Classification Standard (GICS) split then into their own sector.
iShares Preferred and Income Securities ETF yields less than 5% right now. However, that is in part because PFF’s price has been driven up this year by investors looking for stores of stability. Again, preferred shares tend to be far less volatile than common stocks.
Learn more about PFF at the iShares provider site.
Market value: $710.4 million
SEC yield: 5.2%
Expenses: 0.41%*
The VanEck Vectors Preferred Securities ex Financials ETF (PFXF, $20.14) stands apart from most other preferred stock ETFs. All you need to do is look at its name to see how.
PFXF was one of several “ex-financials” ETFs that popped up in the years following the 2007-09 bear market and financial crisis. While most stocks took a beating then, banks and other financial-sector stocks were at the epicenter of the crisis. Trust was eroded, so much so that ETF providers knew they could attract assets by offering products that ignored the sector altogether.
VanEck Vectors Preferred Securities ex Financials ETF, which was introduced in 2012, instead has healthy helpings of electric-utility (32.1%), REIT (23.0%) and telecommunications (10.8%) preferreds, as well as exposure to 15 other industries, such as health-care products, pipelines and agriculture companies. Also, note that PFXF isn’t perfectly protected against the financial sector, thanks to a modest 5% exposure to the insurance industry.
PFXF’s ex-financials nature isn’t as important as it used to be. Banks are far better capitalized and regulated now than they were in 2007, so the risk of another near-collapse doesn’t seem as dire. That said, VanEck’s ETF and its portfolio of more than 120 stocks still hold up today thanks to a combination of higher-than-average yield and one of the lowest fees in the preferred-stock space.
And if you do fear that Washington’s renewed trickle of de-regulation brings America back into a similarly dangerous environment for banks, PFXF is a good place to hide.
* Includes a 5-basis-point fee waiver good until at least Sept. 1, 2020.
Learn more about PFF at the VanEck provider site.
Market value: $36.8 million
SEC yield: 5.7%
Expenses: 0.45%
Virtus Investment Partners’ InfraCap REIT Preferred ETF (PFFR, $25.40) is, like PFXF, among the few preferred stock ETFs that come with a twist. Also like PFXF, that twist is evident in the name.
PFFR invests in a tight group of just 75 preferreds exclusively within the real estate space. Some of those preferreds come from traditional REITs such as commercial player National Retail Properties (NNN) and office-and-retail property owner Vornado Realty Trust (VNO). Others come from so-called mortgage REITs (mREITs) such as Annaly Capital Management (NLY) that own mortgages and mortgage-backed securities rather than physical real estate.
Why REIT preferreds? InfraCap says “these securities are also typically exposed to less leverage with generally more predictable revenue streams than those issued by banks and insurance companies.”
While that’s an attractive proposition, just understand the potential risk involved with putting all your eggs in one sector basket – especially if America enters another real estate crisis like the housing bubble burst of the late aughts.
For now, however, InfraCap REIT Preferred ETF is rewarding investors with one of the best yields among preferred stock funds.
Learn more about PFFR at the Virtus provider site.