Preferred Stock ETFs: Are 6% Yields Worth the Risk?

The iShares S&P U.S. Preferred Stock Index Fund (NYSE: PFF) is up 3% so far this year and just capped its sixth straight quarter of gains to trade at its highest price level since the financial crisis.

For conservative investors who want to avoid volatility and generate yield, preferred stock ETFs have fit the bill nicely. PFF, the category’s largest ETF with $11.9 billion in assets, pays a 12-month yield of 6%.

Slow and steady wins the race, especially for investors shell-shocked by the dot-com meltdown and 2008 global credit storm.

And with the Federal Reserve holding short-term interest rates near zero, investors who rely on income have been forced to take on more risk in search of yield. They have gravitated to ETFs tracking high-yield corporate bonds, dividend stocks and preferred shares, for example.

For over three years, investors in preferred stock ETFs have been able to relax and let those dividend payments roll in like clockwork, with very little price volatility to boot.

“Like stocks, preferreds are traded daily on an exchange. Like bonds, they pay fixed income on a regular basis (usually quarterly) and do not benefit from earnings growth of the issuing company,” explains Morningstar analyst Abby Woodham in a report on PFF. “In the capital structure, preferred stock is senior to common stock but junior to corporate bonds, and preferred shareholders have no voting rights.”

One important risk investors need to consider is the concentration in the financial sector. For example, PFF has about 86% of its portfolio in diversified financials, banks, real estate and insurance. Of course, the recent strong performance of the financial sector has provided a lift.

Currently, preferred stocks are trading at a premium to par, so they’re not a bargain at current prices.

Source:  John Spence, ETF Trends

iShares S&P U.S. Preferred Stock Index Fund (PFF) and PowerShares Preferred (PGX) are components of the D2 Capital Management Multi-Asset Income Portfolio.

The information contained in this article does not constitute a recommendation, solicitation, or offer by 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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