Preferred stocks aren’t usually first, second, or even third in mind when investors think about what to include in their portfolios. But if you’re an income hunter and don’t already have these stocks on their radar, you might want to take a look at preferred stocks — and preferred stock ETFs in particular.
Preferred stocks are often referred to as stock-bond “hybrids” because they contain elements of common stocks (the type of stocks you typically invest in) and bonds. For example, like common stocks, preferred stocks represent ownership of a company and they usually trade on a stock exchange. However, like bonds, preferred stocks generally do not include any voting rights.
The main feature of preferred shares, however, are their dividends. Preferred stock dividends are actually closer to bond coupon payments, in that they are usually set at a fixed amount. These dividends are also high, often in the range of 5-7%.
But preferred stocks also tend to act more like bonds in that they trade around a face value. So while they’re a great source of fixed income, they won’t grow dramatically like common stock as a business grows.
They are also not without risk.
“Because preferred securities have long maturities or no maturities, they tend to present high interest rate risk, or the risk that prices will fall when yields rise,” says Charles Schwab, and indeed , a popular preferred stock index is off. 13% so far in 2022. “Given that preferred stocks should always be viewed as long-term investments, as fluctuating interest rates can have outsized effects on preferred stock prices.”
Although you can easily buy individual preferred stocks, exchange-traded funds (ETFs) allow you to reduce your risk by investing in baskets of preferred stocks. This helps prevent a single preferred stock disaster from sapping your portfolio.
With that in mind, here are three preferred stock ETFs to buy.
Data is as of May 26. The SEC return reflects interest earned for the most recent 30-day period after deducting fund expenses. SEC yield is a standard metric for preferred stock funds.
iShares Preferred and Income Securities ETF
- Assets under management: $15.8 billion
- DRY yield: 4.7%
- Expenses: 0.46%, or $46 annually on a $10,000 investment
the iShares Preferred and Income Securities ETF (PFF, $34.25) is the largest and most liquid preferred stock ETF on the market. With $15.8 billion in assets under management (AUM), it’s about 2.5 times the size of its second largest competitor, First Trust Preferred Securities & Income ETF (FPE). It is also cheaper than FPE by 39 basis points (one basis point equals one hundredth of a percentage point).
PFF is as simple as it gets, and many competitors (but not all) are built the same way.
The ETF invests in nearly 500 different preferred stocks, almost entirely from US-based companies. The lion’s share of PFF’s preferred stocks (more than 60%) come from companies in the financial sector such as Wells Fargo (WFC) and Bank of America (BAC). Another 22% comes from the industrial sector and 14% from public services. The small remainder is swallowed up in cash and agency bonds.
iShares Preferred and Income Securities ETF is currently yielding less than 5%, but this is still much better than most sources of return in the stock and bond markets.
Learn more about PFF on the iShares vendor site.
VanEck Vectors Preferred Securities ex Financials ETF
- Assets under management: $984.9 million
- DRY yield: 5.7%
- Expenses: 0.40%
the VanEck Vectors Preferred Securities ex Financials ETF (PFXF, $19.19) stands out from most other preferred stock ETFs. All you have to do is look up his name to see how.
PFXF was one of many “ex-financial” ETFs that emerged in the years following the bear market and financial crisis of 2007-09. While most stocks were battered at the time, banks and other financial sector stocks were at the epicenter of the crisis. Trust was eroded, so much so that ETF providers knew they could attract assets by offering products that completely ignored the sector.
VanEck Vectors Preferred Securities ex Financials ETF, which was introduced in 2012, instead has a good portion of electric utilities (33%), real estate investment trust or REITs (15%) and telecommunications services (10 %), as well as exposure to a dozen other sectors, such as healthcare equipment, semiconductors and diversified retail.
The ex-financial nature of PFXF is no longer as important as it once was. Banks are much better capitalized and regulated today than they were in 2007, so the risk of another near-collapse doesn’t seem as dire. That said, VanEck’s ETF and its nearly 130% stock portfolio still hold up today thanks to a combination of above-average yield and one of the lowest fees in the preferred stock space. .
Learn more about PFF on the VanEck supplier site.
InfraCap REIT Preferred ETF
- Assets under management: $70.8 million
- DRY yield: 6.8%
- Expenses: 0.45%
Virtus Investment Partners InfraCap REIT Preferred ETF (PFFR, $19.83) is, like PFXF, among the few preferred stock ETFs that come with a twist. Also like PFXF, this twist is evident in the name.
PFFR invests in a select group of approximately 100 exclusively in the real estate business. Some of these preferences come from traditional REITs such as data center operator Digital Realty (DLR) and office and retail owner Vornado Realty Trust (VNO). Others come from mortgage REITs (mREITs) such as Annaly Capital Management (NLY) that own “paper” – mortgages and mortgage-backed securities – rather than physical real estate.
Why REIT prefer?
InfraCap states that “these securities are also generally exposed to less leverage with generally more predictable revenue streams than those issued by banks and insurance companies.”
While that’s an attractive proposition, just understand the potential risk of putting all your eggs in one sector basket – especially if America enters another real estate crisis like the bursting of the housing bubble of the end of the years. Even in an almost bear market like the downturn we experienced in 2022, it underperforms other more traditional REITs by a few percentage points.
On the other hand, InfraCap REIT Preferred ETF rewards new funds with one of the best returns among preferred stock funds.
Learn more about PFFR on the Virtus provider site.