With several companies having cut dividends recently, you may want more certainty from your stock income. If you like priority when it comes to dividend payments and are willing to give up some capital-gains potential, exchange-traded funds that focus on preferred stocks may be worth a look. These funds provide a way to diversify your portfolio that differs from the usual fixed-income choices.
The scoops on preferred stocks
Preferred stocks are hybrid investments with some of the characteristics of both stocks and bonds. Preferred shareholders are positioned higher in the pecking order than owners of common stock if a company liquidates or declares bankruptcy, but they're junior to holders of corporate bonds and other debt. The fixed dividend these stocks typically distribute must be paid prior to any dividends being paid to common shareholders.
Preferred stocks have many of the disadvantages of both stocks and bonds without enjoying the full advantages of either. Like a bond, preferred stock does not participate in any future earnings and dividend growth of the company, nor does it profit from any resulting growth in the price of the common stock. A bond, however, has greater security than the preferred and has a maturity date at which the principal is to be repaid. Like common stock, preferred shares have less security protection than a bond and don't necessarily have a date on which investors will get their investment back.
Three preferred ETFs
Currently, there are three preferred stock ETF options, one from Barclays Global Investors and two from PowerShares. The iShares S&P U.S. Preferred Stock Index Fund (AMEX: PFF) tracks an index that includes preferred stocks of companies that have a market capitalization of more than $100 million and are listed on major U.S. exchanges. The fund holds nearly 60 different stocks, with top holdings including shares of a Ford (NYSE: F) subsidiary as well as Freeport McMoRan (NYSE: FCX). Other top holdings are from the financial sector and include many names you'd recognize from the subprime crisis. Financials make up 78% of the fund, with materials and consumer discretionary stocks making up most of the remaining assets.
The PowerShares Financial Preferred Portfolio (AMEX: PGF) is based on an index that tracks preferred stocks issued by financial institutions. Its largest holding is in Royal Bank of Scotland (NYSE: RBS) securities, accounting for roughly 17% of assets.
The newest preferred-stock ETF is the PowerShares Preferred Portfolio (AMEX: PGX), launched last week. The fund follows an index that consists of investment-grade preferred securities. The fund has nearly 50 stocks, with Citigroup (NYSE: C) the largest holding, at nearly 9.5%.
|
Fund |
Inception Date |
Expense Ratio |
Net Assets |
|---|---|---|---|
|
PFF |
3/26/07 |
0.48% |
$139 million |
|
PGF |
12/1/06 |
0.60% |
$176 million |
|
PGX |
1/31/08 |
0.50% |
$2 million |
Are they right for you?
All three of these ETFs have heavy financial-sector exposure, but that should come as no surprise, since financial companies are among the primary issuers of preferred stock. Still, if financials continue to fester, this exposure means there's some risk going forward. The current offerings, despite their heavy financial-sector focus and commensurate risk, also include some downside protection in the form of their dividend payments.
While preferred stocks may appreciate in value, that appreciation typically occurs in a range far below that of common stock. If you are seeking growth, it is far easier and better to invest in an ETF that holds common stock. If you are looking for yield, then a corporate or municipal bond fund should also be a consideration, since the underlying investments provide a more senior and secure claim, as opposed to the subordinate position offered by most preferred stocks.
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