In today’s low interest rate environment, preferred stocks and ETFs, such as the Global X U.S. Preferred ETF (PFFD), can play important roles in helping yield-starved investors generate much-needed income.
Preferred stocks are a type of hybrid security that show bond- and equity-like characteristics. The shares are issued by financial institutions, utilities and telecom companies, among others. Within the securities hierarchy, preferreds are senior to common stocks but junior to corporate bonds. Additionally, preferred stocks issue dividends on a regular basis, but investors don’t usually enjoy capital appreciation on par with common shares.
PFFD, which debuted in September 2017, tracks the ICE BofAML Diversified Core U.S. Preferred Securities Index. The fund has $753.66 million in assets under management, meaning it has more than doubled in size since last July.
Income investors have looked to preferred stock ETFs in their portfolios for a number of reasons. For instance, the asset class offers stable dividends, does not come with taxes on qualified dividends for those that fall into the 15% tax bracket or lower, is senior to common stocks in the event liquidation occurs, is less volatile than bonds and provides dividend payments before common shareholders.
“Preferred equity has characteristics of both equity and fixed income. Within the capital structure, preferreds are above common equity and below bond holders,” said Global X in recent research piece. “Holders of preferred equity receive dividend income ahead of common equity owners. While this protects the income component of preferreds, they don’t have the same price return potential as common equity.”
PFFD’s underlying index includes different categories of preferred stock, such as floating, variable and fixed-rate preferreds, cumulative and non-cumulative preferreds, and trust preferreds. Components of the Underlying Index primarily include financials, real estate, telecommunications, and utilities companies.
PFFD, which has a 30-day SEC yield of 5.28%, allocates 63.22% of its weight to preferreds issued by financial services firms.
Nearly 88% of the fund’s holdings have credit ratings ranging from BB- to BBB+.
“Preferreds have historically offered high yields compared to more traditional fixed income instruments. In addition, the yield from preferred stocks may be treated as qualified dividend income (QDI) rather than as ordinary income, resulting in favorable taxation,” according to Global X.
This article originally appeared on ETFTrends.com.