Why It Is A Good Idea To Prefer Preferred ETFs

Income investors are loving life in 2016. The Federal Reserve has yet to raise interest rates and with each passing month without a rate hike, it appears increasingly likely that the most rate hikes coming this year will be two.

Predictably, this scenario has been a boon for plenty of income-generating asset classes and sectors, including preferred stocks and exchange traded funds. 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.

The iShares U.S. Preferred Stock ETF PFF, which tracks the S&P U.S. Preferred Stock Index, is among the preferred ETFs benefiting from the Fed's reluctance to raise rates. Year-to-date, PFF has added $738.3 million in new assets. With a trailing 12-month yield of 5.8 percent, it is easy to see why investors are fond of PFF.

Preffered 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.

PFF has an international counterpart, which has benefited from low and negative interest rates throughout the ex-U.S. developed world. The iShares International Preferred Stock ETF IPFF, which follows the S&P International Preferred Stock Index, has added nearly $77 million in fresh capital this year. That is an especially tally when considering IPFF now has $108.7 million in assets under management.

IPFF, which yields 6.1 percent on a trailing 12-month basis, devotes a combined 90.5 percent of its weight to Canada and U.K. preferreds. IPFF is more exposed to the impact of oil prices on preferreds than is PFF.

“The S&P International Preferred Stock Index has over 20% exposure to companies in the energy sector; meanwhile, the S&P U.S. Preferred Stock Index has no exposure.  As a result, the U.S. index has significantly outperformed its international counterpart.  Since August 2014, the S&P U.S. Preferred Stock Index was up 10.0%, while the S&P International Preferred Stock Index was down -27.5% as of March 2016,” adds S&P Dow Jones Indices.