Preferred ETFs Get Preferential Treatment As Rates Swoon

Count preferred stocks and the related exchange traded funds among the beneficiaries of declining interest rates this year. Several preferred ETFs currently reside at or close to 52-week highs.

The VanEck Vectors Preferred Securities ex Financials ETF PFXF is one of those funds. Up 13.12% year to date, PFXF closed just 1.33% below its 52-week high on Wednesday.

PFXF tracks the Wells Fargo Hybrid and Preferred Securities ex Financials Index, giving it a unique approach among funds in this category. Most are laden with preferred stocks issued by banks, a relic of the global financial crisis when banks turned to preferred stock issuance as an avenue for raising capital.

Why It's Important

The history of the $744.7 million PFXF is relevant, but so is the current, favorable environment for preferred stocks. Like other high-yield asset classes (PFXF has a 30-day SEC yield of 5.30%), preferreds are vulnerable to rising interest rates. Conversely, accomodative monetary policy usually benefits PFXF and friends.

“Historically, a company’s preferred securities have offered higher yield than its common stock or senior debt,” VanEck said in a recent note. “However, with traditional financial companies saturating the market, this traditional scenario is not playing out the way it once had. Targeting preferred securities ex-financials may provide investors with a yield premium, most effectively spent allocating to the broad preferred market in aggregate.”

Importantly, PFXF's strategy of eliminating financial services preferreds isn't a gimmick. It's a winning methodology. Over the past three years, the fund has outperformed the largest preferred ETF by 550 basis points.

What's Next

In addition to the tempting yields, preferreds offer another perk: low correlations to other asset classes.

“For investors seeking yield in the current low rate environment, preferred securities can potentially offer increased income generation within a portfolio,” according to VanEck. “In addition, their low correlations with equities and traditional fixed income instruments can make them a useful diversifier in portfolios. Preferreds can serve as a complement to a portfolio’s core fixed income allocation alongside or in place of high yield debt.”

PFXF's five-year correlation to U.S. stocks is just 0.52 and to domestic junk bonds, it's just 0.59, according to issuer data.

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