Peeking In On Another Preferred ETF
Well-documented is the fact that preferred stocks and the corresponding exchange-traded funds are among the beneficiaries of the Federal Reserve's lower for longer interest rate policy. It is also well-known that higher yielding asset classes, including preferred stocks, are seen as vulnerable to rising interest rates.
A preferred stock is a type of security that offers characteristics of both bonds and equities. The primary source of allure with preferreds is yield, although preferred shareholders are higher on the totem pole in the event of issuer bankruptcy or default than are common equity holders.
Bond Aspects, Yields And Dividends
Looking at the yields on preferred ETFs, such as the SPDR Wells Fargo Prfd Stk ETF (NYSE: PSK), it is easy to see why some investors view preferred as vulnerable to rising rates. For its part, PSK has a current yield of just over 6 percent. Lower volatility is another reason investors embrace preferreds.
“The bond-like aspects of their structure mean that most preferreds are comprised of a fixed principal value and a fixed future stream of dividends. As such, their present value is easier to deduce than that of common equities and they tend to trade within a much tighter range, illustrated by a standard deviation of 3.60 compared with 13.95 for the S&P 500,” said State Street Vice President David Mazza in a recent note.
Preferred stocks and ETFs have another advantage: Even if the issuer cuts or suspends the dividend on its common stock, it essentially must continuing pay preferred dividends.
Looking Closer At PSK
The $543.7 million PSK, which launched in 2009, is like many of the legacy preferred ETFs in that the financial services sector accounts for the bulk of the ETF's lineup. More than 79 percent of the 151 preferred stocks held by PSK hail from financial services issues. Over nine percent combined come telecom and utilities issuers.
Income investors embraced preferred stocks, in large part, because of high yields, but as the spike in Treasury yields earlier this year and in 2013 taught investors, high-yielding assets are vulnerable to rising rates.
Of course, sensitivity to rising rates comes by way of a bond's duration; the longer the duration, the more sensitive it is to fluctuations in interest rates.
“Despite these risks, State Street Global Advisors believes that in today’s market preferreds can serve as a complement to a well-diversified core fixed income allocation. While not traditionally utilized in a rising rate environment, the pace at which the Fed has signaled they will raise rates means that the yield benefits of preferred securities may outweigh the risks of principal loss,” added Mazza.
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