Preferred Stock Funds Offer High Yields

By Tom Lydon, ETF Trends

Preferred stocks are a type of hybrid security that show bond- and equity-esque 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. Preferred stocks issue dividends on a regular basis, but investors are unlikely to enjoy capital appreciation on par with common shares.

Exchange traded funds that track preferred stocks provide investors with an attractive source of yields. However, as witnessed last year, preferred shares are vulnerable to rising interest rate environments.

As benchmark 10-year Treasury yields stay below 3%, Investors have found preferred stocks as an attractive alternative source of income.

Nevertheless, with the Fed tapering its bond purchasing program and looking to the jobs market and economy as indicators for the eventual hike in benchmark rates, preferred stocks could be vulnerable ahead.

Preferred stock ETFs began to decline in May 2013 on Fed tapering and on concerns of rising interest rates.

“Much like bonds, preferred stock becomes less attractive in a rising rate environment, so preferred stocks must decline in price to bring their yield up to an attractive level,” according to Morningstar analyst Abby Woodham. “Most preferred stock is either perpetual or extremely long-dated, which exposes investors to significant interest-rate risk.”

Moreover, investors need to be aware that preferred stock ETFs have a heavy exposure to the financial sector.

The PowerShares Preferred Portfolio (NYSE: PGX) employs a credit screen, so component holdings have a higher credit quality than other preferred ETFs. The financial services sector also looms large in the fund, accounting for 87.9% of its holdings. PGX shows a 6.41% 12-month yield, The ETF is up 5.2% year-to-date.

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PowerShares Preferred Portfolio (PGX) is a component of the D2 Capital Management Multi-Asset Income Portfolio. 

Disclosure:  I own the D2 Capital Management Multi-Asset Income Portfolio

The views expressed here are that of myself or the cited individual or firm and do not constitute a recommendation, solicitation, or offer by myself, D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

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