Preferred ETF: Steady path for income

by Mark Salzinger, editor The Investor's ETF Report

Market Vectors Preferred Securities ex-Financials (PFXF) adds a unique portfolio restraint that we think could make the new offering more attractive than its peers.

It invests in preferred issues but excludes those from financial services companies, which have contributed the most to volatility over the past decade. This could make PFXF a steadier way to earn the higher income available from preferreds.

Preferred securities occupy a no-man’s land in corporate credit structure. Portfolios of preferred issues tend to hold several different kinds of securities, including trust preferred notes, junior subordinated notes and preferred stock.

Besides their lower standing in credit structure, preferred securities also can be callable by the issuer, can have deferrable interest or dividend payments and are subject to the same market,
interest rate and credit risks of bonds and high-yielding stocks.

Consequently, they tend to yield significantly more than common stock, often comparable to long-term, medium-quality bonds.

As a group, preferred securities have yielded about 2.8 percentage points more than 30-year U.S. Treasuries over the past decade (including the huge spike in the spread between preferred and long Treasury yields in 2008).

Recently, the spread was about 3.9 percentage points, according to Market Vectors, so preferred securities don’t seem particularly expensive from a historical perspective, even with recent surging interest from investors in their higher payouts.

On the other hand, most portfolios of preferred stocks have been significantly more volatile than diversified equity portfolios and high-yield bonds. That’s largely a function of the substantial weighting given to financials in most preferred indexes.

Despite higher volatility, financial preferred securities recently had a comparable average yield to non-financial preferreds, suggesting that investors receive no compensation for accepting their additional volatility.

Enter PFXF. The intent of this fund appears to be to exclude banks. The single largest allocation (about a third) is to real-estate investment trusts. Utilities get another 26%, which also should help dampen volatility, as utilities tend to be among the least volatile sectors.

Positions in automobile manufacturers, telecommunications, insurers and energy companies round out the portfolio, at 12%, 8%, 6% and 5%, respectively.

This ETF has fairly low credit quality. About 41% of the portfolio is in BBB-rated companies, the lowest tier of investment- grade ratings. Another 18% are rated BB, the highest below-
investment-grade rating, but more than one-third of the portfolio (35%) is in unrated securities.

These aren’t necessarily risky; they simply aren’t rated by a credit-rating agency, most likely because they were not issued in very large amounts or because they are thinly traded. PFXF holds about 70 securities and recently yielded 6.3%

Learn more about this financial newsletter at Mark Salzinger's The Investor's ETF Report.

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