In the wake of the Facebook IPO, investors have started looking at initial public offerings with an air of skepticism. But in the world of exchange-traded funds, new ETFs pop up all the time, and some of them make investors almost as excited as they were about Facebook before its offering fiasco.
A couple of funds set to premiere later this week focus on a little-followed area of the financial markets: preferred stock. Even with the recent emphasis on investments that produce income, many investors still don't know much about preferred stock. Given the current market environment, do these preferred ETFs have the chance to whip the social media giant over the long run?
The two coming ETFs are Market Vectors Preferred Securities ex-Financials and Global X SuperIncome Preferred. The funds seek to add to a stable of existing ETFs, including the popular iShares S&P Preferred Stock Index (NYSE: PFF ) and the PowerShares Financial Preferred Portfolio (NYSE: PGF ) .
But each of the new ETFs goes after a different niche. The Market Vectors ETF avoids the emphasis on financial stocks that the iShares ETF has, with nearly 80% of the iShares ETF aimed at banks, financial services, insurance, and related finance-based companies. Instead, the Market Vectors ETF will focus on other sectors, with securities from Ford (NYSE: F ) , utility PPL (NYSE: PPL ) , and the Qwest subsidiary of CenturyLink (NYSE: CTL ) . Meanwhile, the Global X ETF looks for top-yielding preferred stocks, regardless of whether financial companies or other issuers back them.
Why you should prefer preferreds
Before considering these funds in particular, the threshold question you should ask yourself is whether you should invest in preferred stock in the first place. The answer depends on your investment objectives, because preferred stock behaves very differently from common stock.
With common shares, investors get unlimited upside along with the risk of total loss. Some stocks pay dividends, but they're not guaranteed, and companies can stop paying them at any time.
By contrast, preferred stock typically has limited upside, as the issuing company usually retains the right and often even the obligation to redeem its preferred shares at a certain price in the future. Yet preferred stock gets preferential treatment with dividends; yields are generally higher, and preferred shareholders must get paid before common shareholders can receive any dividend payments. In many ways, therefore, preferred stock acts more like a bond, floating up and down with interest rates.
Where to look for the best preferreds
Between the two new ETFs, the Market Vectors offering has greater promise. With both the iShares and PowerShares preferred ETFs, you have to be very comfortable about the future prospects for the banking and financial industry. With so much sector-specific risk, the token securities those ETFs hold from other industries really don't do much to provide real diversification.
But for those with large positions in financial-heavy preferred ETFs, the Market Vectors ETF could help you balance out your preferred portfolio to take away some of that concentration. By contrast, the Global X ETF itself has plenty of financial exposure, with the newly created S&P Enhanced Yield North American Preferred Stock Index having 89% exposure to financials.
Don't worry about this IPO
The nice thing about ETF IPOs is that it isn't hard to get shares. With essentially unlimited potential to create shares, you should never have to pay a big premium to get in on an ETF you find promising.
Whether preferred ETFs make sense for you depends on whether you're more focused on current income or growth potential. If you need your investment to grow considerably in value, then preferred stock generally won't give you the chance at explosive growth that common shares will. On the other hand, if you're at a point at which high dividend income is more important than price appreciation, then preferreds are worth a closer look.
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