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This Preferred ETF Could Be Providing Fed Clues

October 17, 2016 11:44 am
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Traders are increasingly reconciling the fact that the Federal Reserve will raise interest rates in December.

That speculation is prompting some pressure on rate-sensitive asset classes, as highlighted by recent retrenchments in real estate and utilities stocks and exchange-traded funds. Preferred stocks and ETFs could also be pressured as the market edges closer to its first rate hike of the year, but there are ways to deal with this dilemma.

Preferreds can be considered an alternative asset class, implying that these hybrid securities can potentially boost a portfolio's diversity and reduce correlations to other asset classes along with providing higher yields.

The PowerShares Variable Rate Preferred Portfolio (PowerShares Exchange-Traded Fund Trust II (NYSE: VRP)) is a way for investors to stay engaged with preferreds in the face of rising interest rates. Preferreds and the funds that hold them are viewed as vulnerable to hawkish changes in Fed policy, but VRP has the tools to help income investors stick with preferreds while weathering interest rate increases.

Index, Yield And Rising Risks

VRP tracks the Wells Fargo Hybrid and Preferred Securities Floating and Variable Rate Index. The ETF is just two and a half years old with a stellar $875 million in assets under management.

Related Link: A Power Preferred ETF

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.

As its name implies, VRP holds preferred stocks with variable interest rates, making the fund less vulnerable to changes in interest rates. Variable rate preferreds offer another advantage: Mitigation of extension risk.

A Look Into The Future?

A cursory glance of VRP might leave investors the trade-off for reduced sensitivity to rising interest rates is a lower yield. That is not the case with VRP has highlighted by the ETF's 30-day SEC yield of 4.9 percent. Importantly, that tempting yield does not mean investors are forced to incur significant credit risk as 59 percent of VRP's holdings are rated BBB.

There are signs investors are betting rates will soon rise and are using VRP to deal with that scenario. Over the past month, VRP has added nearly $51 million in new assets, a total exceeded by just four other PowerShares ETFs, according to issuer data.

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