Fed Indulges This Preferred ETF

As has been widely documented, preferred stocks and exchange traded funds are benefiting this year from the Federal Reserve's refusal to raise interest rates, something the U.S. central bank recently passed on.

Like other high-yielding asset classes, preferred stocks and the corresponding ETFs are viewed as negatively correlated to hawkish changes in U.S. borrowing costs. So it's not surprising that with the Fed standing pat on interest rates, preferred ETFs have been packing on new assets at an impressive, including the PowerShares Variable Rate Preferred Portfolio VRP.

VRP, which tracks the Wells Fargo Hybrid and Preferred Securities Floating and Variable Rate Index, is just 25 months old and has almost $674 million in assets under management, making it one of the most successful ETFs, fixed income or otherwise, to come to market last year. 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.

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Income investors embraced preferred stocks, in large part, because of high yields, but as the spike in Treasury yields last 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.

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.

“Unlike common stock, most preferred dividends are cumulative, meaning dividend payments accrue even if not paid when scheduled. If a firm suspends paying dividends, it must pay preferred shareholders in full before paying any dividends to common shareholders,” said S&P Dow Jones Indices in a recent note.

Although VRP can be seen as the preferred ETF designed explicitly to endure rising rates (it is), that doesn't mean investors make a sacrifice when it comes to yield or income. VRP has a 30-day SEC yield of nearly 5.2 percent. And that does not mean significant credit risk as 91 percent of the ETF's holdings are rated BBB or BB.

Investors clearly like the VRP story as highlighted by it $44.2 million in inflows over the past month, a total exceeded by just seven other PowerShares ETFs.