Many investors are looking to reduce equity volatility while adding more non-Treasury income to their portfolios. In this environment, preferred stocks and the related ETFs may be valid considerations.
Preferred stocks are often referred to as hybrid securities because they display both equity and fixed income traits. They pay steady dividends and usually sport higher yields than what investors find with investment-grade corporate bonds. However, the universe of preferred ETFs was largely stagnant until the VanEck Preferred Securities ex Financials ETF (PFXF ) burst onto the scene nearly 14 years ago.
As its name implies, the $2.12 billion ETF excludes preferred stocks issued by financial services – a potentially advantageous methodology. As VanEck noted, while financial companies are the largest issuers of these securities, legacy ETFs in this category invite some risk should the financial services sector encounter periods of duress, declining credit quality or periods in which interest rates aren’t cooperative.
PFXF Is Pertinent Today
PFXF carries a 30-day SEC yield of 6.60%. It may be appealing to a broad swath of investors in the current environment. This is likely amplified by a turbulent stock market and an indecisive Federal Reserve.
“They are often used by income-oriented investors looking to diversify fixed income allocations, enhance yield, or reduce reliance on common equity dividends. Because preferreds sit lower in the capital structure than bonds, credit analysis and active management can play an important role in managing risk,” according to VanEck.
Regarding PFXF’s sector exposures, obviously financial services preferreds aren’t part of the equation. PFXF leans more heavily into preferred shares issued by industrial companies, real estate investment trusts (REITs), and utilities.
Each of those sectors presents with income investors with risks and benefits to consider. Market participants should note that REIT balance sheets are currently strong. Additionally, funds from operations (FFO) are trending the right way, indicating these companies have the ability to service preferred obligations.
As VanEck pointed out, utilities-issued preferreds have bond-like features. However, they also have the benefits of less cyclical cash flows and “potentially lower yields but higher perceived stability.” There’s an arguably wider audience for preferreds and ETFs like than PFXF than the asset class is given credit for.
“Preferred securities may be appropriate for investors seeking enhanced income potential with lower volatility than equities, but who are willing to accept more risk than traditional investment-grade bonds,” added VanEck.
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