Preferred Stocks Gone Wild: Will You Be Safe Or Sorry?

March 04, 2009

 

The Playing Field 

A number of closed and open-end mutual funds exist which specialize in preferred stocks, but there are three exchange-traded funds that accomplish the same task less expensively and with greater tax efficiency. Those are:

  • The PowerShares Financial Preferred Portfolio (NYSE: PGF), which tracks the price and yield of the Wachovia Hybrid & Preferred Securities Financial Index. It 42 holdings, daily trading volume of 1.3 million shares a day, a current distribution rate of 18.9% and an expense ratio of 0.72%.
  • The PowerShares Preferred Portfolio (NYSE: PGX). It tracks the Merrill Lynch Fixed Rate Preferred Securities Index. PGX has a current distribution rate of 13.6%, trades 552,000 shares a day on average, has 78 holdings and comes with an expense ratio of 0.50%. 
  • The iShares S&P U.S. Preferred Stock Index (NYSE: PFF). This ETF tracks the price and yield performance of the S & P U.S. Preferred Stock Index. Preferred stocks in the index must have market capitalization exceeding $100 million. The index may include a wide selection of differing preferred categories, including trust preferreds, fixed and adjustable rate preferreds, convertible preferreds and perpetual preferred stocks. It has a current distribution rate of 13.7%, trades 1.8 million shares a day, has 69 holdings and charges an ER of 0.48%. 

Don't Back Up The Truck Yet

A long-term investor might point to the historically wide yield spreads preferred stocks are paying versus U.S. Treasuries, investment-grade corporate bonds and municipal bonds. Yields on 10-year Treasury bonds, for example, are currently at 2.9%. Again, with preferred stocks averaging 15.4%, the math would seem fairly straightforward.

Yet "going all in" during these early phases of Federal bank intervention might be a risky bet. A much sounder strategy for safety-minded and yield-starved investors would be to wade into preferred stocks incrementally over the next six- to nine-months.

Preferred shares will undoubtedly rally and collapse again in 2009, perhaps even a number of times, before it is safe to fully venture back into this high yielding sector. So, go slow—there's no reason to back up the truck and start loading up on preferreds in this environment. 

But it's not a bad idea to get started now. The yields are remarkable and the robins just might return earlier than you think. 


Chance Carson is president of Alpine Strategies in Colorado Springs, Colo. He also serves as editor of www.AboutETFs.com, an educational Web site for retired investors. He welcomes comments and suggestions for future columns at: [email protected].

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