Hiding Out With A Preferred Stock ETF

Less than two months removed from the Federal Reserve's first interest rate hike in nearly a decade, volatile global equity markets have renewed investors' enthusiasm for rate-sensitive asset classes.

That theme explains why five of this year's top 10 asset-gathering exchange traded funds are fixed income funds and one of the other five is the Utilities Select Sector SPDR XLU. Although investors have pulled $62 million from the iShares U.S. Preferred Stock ETF PFF since the start of the year, the time could be right for investors to consider PFF and rival preferred stock ETFs.

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.

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, though preferred shareholders are higher on the totem pole in the event of issuer bankruptcy or default than are common equity holders. In the case of PFF, the ETF is undoubtedly tempting with a trailing 12-month yield of almost 5.8 percent.

As is the case with bonds, preferreds are sold at par value, or offer a fixed or floating rate of income, so prices fluctuate with interest rates, wrote William Scapell, director of fixed income and preferred securities portfolio manager at Cohen & Steers, for InvestmentNews.

“Most preferred issues tend to be banks and other financial companies. Following massive regulatory changes in the financial sector, the U.S. banking sector is considerably less leveraged and arguably safer than it was pre-crisis. So, while more boring than they once were, U.S. financials may be well positioned to potentially provide a dividend stream,” said BlackRock Global Chief Investment Strategist Russ Koesterich in a recent note. 

PFF certainly fits the bill as an avenue for skirting volatility. The ETF's beta is just 0.17 with a three-year standard deviation of just under 4.1 percent. PFF, which tracks the S&P U.S. Preferred Stock Index, is home to 281 preferred issues.

Preferred stock ETFs are among the assets that can't be counted on“to produce massive, double-digit returns. Investors looking for more aggressive profits probably need to test their nerves and try to time the market bottom. For the rest, a better approach may be seeking more modest returns with lower volatility, via a focus on portfolio construction, risk exposures and less traditional asset classes,” adds Koesterich.