With bond yields tumbling, it would be easy to think that these would be go-to days for preferred stocks and related ETFs. That’s not the case. Many traditional preferred ETFs allocate substantial portions of their rosters to preferreds issued by financial services, which are seeing net interest margins depressed by the Federal Reserve’s assault on interest rates.
Investors wanting to tap the income benefits of this asset class while avoiding bank issues should consider the VanEck Vectors Preferred Securities ex Financials ETF (PFXF ), the one preferred ETF not tied up in bank preferreds.
PFXF seeks to replicate as closely as possible, before fees and expenses, the price and yield performance of the Wells Fargo Hybrid and Preferred Securities ex Financials Index. The Index is intended to track the overall performance of U.S.-listed preferred securities excluding those with a financial sector classification, including securities that, in Wells Fargo Securities LLC’s judgment, are functionally equivalent to preferred securities such as convertible securities, depository preferred securities and perpetual subordinated debt.
“Yields for many income-producing assets ticked up in September, breaking what had been a multi-month downward trend from March highs,” writes VanEck analyst Coulter Regal. “The recent rise in yields was in part due to growing uncertainty around the economic recovery, U.S. presidential election, and prospect of an additional stimulus package, which caused widening spreads. These may continue to weigh on markets in the coming months, and investors should expect increased volatility at least through the elections. Despite these uncertainties, there are still attractive segments of the income market that may provide opportunity for investors.”
PFXF's 'Exclusionary Strategy'
Home to nearly $760 million in assets under management, PFXF yields an impressive 5.60%, underscoring its allure in the current climate.
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 regularly, but investors don’t usually enjoy capital appreciation on par with common shares.
Preferred stocks also act like bonds. Par value is assigned on issue, and this price rises or falls based on interest rates. When interest rates go up, the par value of the shares is diminished, just like bonds. Some preferred shares even have a maturity date where the investors’ capital is returned. Finally, some preferred shares are callable, meaning the company can decide at any time to repurchase the shares (although usually at a premium).
There are benefits to PFXF’s exclusionary strategy.
“Excluding financial issuers also increases the proportion of preferreds paying cumulative distributions and lowers the proportion featuring near-term call dates relative to the broad preferreds market. These are especially important characteristics in today’s environment, where there are concerns of dividend suspensions and high incentive for issuers to call and reissue securities with lower rates,” according to Regal.