Preferred stocks and the related exchange traded funds have long been favored assets of income-hungry investors, but there are some rubs with preferreds.
First, these hybrid securities are rate-sensitive — a trait that worked against preferreds last year, but could turn positive when the Federal Reserve shows signs of halting its tightening regime. Second, the bulk of preferred securities are issued by banks — an industry recently under significant duress owing to the collapse of Silicon Valley Bank (SVB), among others.
Most preferred ETFs reflect the fact that banks are the dominant issuers of these securities, allocating substantial portions of their rosters to bank-issued preferreds. Investors can skirt that scenario and potentially avoid some trouble along the way with the VanEck Preferred Securities ex Financials ETF (PFXF ).
PFXF, which follows the ICE Exchange-Listed Fixed & Adjustable Rate Non-Financial Preferred Securities Index, lives up to its billing because none of its 118 holdings are issued by traditional money center banks. The ETF has a 1.17% allocation to preferreds issued by investment banks, but that’s well below the category average. That’s just one data point, but it underscores PFXF’s uniqueness within its peer group.
“Following the financial crisis in 2008, banks and other financial institutions began issuing a significant amount of preferred stock to meet the higher capital levels required by regulators,” wrote Coulter Regal, VanEck associate product manager. “This proliferation of preferreds issuance by financials resulted in the sector’s concentration, which now makes up over 75% of the U.S. preferreds market. Drilling down even further, the Banking Industry is specifically responsible for about half of this financial concentration, with the remainder being financial services and insurance companies.”
Industry, banks, insurance companies, and broader financial services account for 77% of the domestic preferred stock universe. However, thanks to tumult in the banking industry, that trait introduces a host of vulnerabilities to investors evaluating traditional preferred ETFs. Fortunately, PFXF is a valid alternative.
“For preferred security investors looking to avoid some of this volatility, a potential solution is to simply avoid preferreds issued by companies operating in the financial sector. Expectedly, ex-financials preferreds have held up better in this volatile period than the broader financial heavy preferreds universe,” added Regal.
Year-to-date, PFXF is higher by 4.7%, beating the largest preferred ETF by 300 basis points. Additionally, the VanEck fund is sporting annualized volatility that’s 260 basis points below that of the largest competitor in the category. All that with a 30-day SEC yield of 6.78%.
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