This Preferred Stock ETF Top Fixed Income Performer

A preferred stock ETF is the year’s best-performing fixed-income fund to date, leading a segment that’s delivering solid returns.

The best-performing fixed-income ETF so far in 2017 is, actually, an equity fund—a preferred stock fund, to be exact.

The iShares International Preferred Stock ETF (IPFF) has delivered the strongest returns among fixed-income ETFs year-to-date.

The fund has delivered roughly twice the gains of its U.S.-focused counterpart, the iShares U.S. Preferred Stock ETF (PFF)—albeit with greater volatility—and significantly higher returns than both a broad fixed-income allocation, as measured by the iShares Core U.S. Aggregate Bond ETF (AGG), and an equity allocation, as measured by the SPDR S&P 500 (SPY).

Preferred stocks are equities that behave like a bond. They typically deliver income in the form of fixed dividends, and they carry less risk than other equity securities due to their ranking in the corporate ladder.

These traits are the reason many investors include preferreds in their fixed-income allocation. They fulfill two key roles in a fixed-income allocation: diversification and additional income.

About IPFF & Other Preferred ETFs

One of the drivers of IPFF’s outperformance is strong income. IPFF currently has a 12-month trailing yield of 4.7%, according to iShares data. The higher the income relative to common stocks, the better the results.

Also, IPFF is heavily allocated to Canada—78% of the portfolio—and, in particular, Canadian banks. The Canadian financials sector is outperforming the broad composite as measured by the S&P/TSX Composite Index. The U.K. is the fund’s second-largest country allocation, at about 11%. IPFF invests in non-U.S. developed markets. 

According to Michael McClary, chief investment officer of ValMark Advisers, IPFF is more sensitive to global risk events, which have not been occurring lately. He notes that the fund can act like emerging market debt. 

But there are other reasons to like IPFF and preferred stock ETFs in general.

First, they typically offer a lower level of risk for what is a pretty good yield. To get similar yields in the corporate bond space, investors would have to take on the risk of high-yield bonds.

Consider that the largest investment-grade corporate bond fund, the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) has a 12-month trailing yield of 3.3%—nearly 1.5 percentage points lower than IPFF’s. The high-yield segment, as measured by the iShares iBoxx $ High Yield Corporate Bond ETF (HYG), is shelling out 12-month trailing yields of 5.3%.

More Reasons To Allocate To Preferred ETFs

Ben Lavine, chief investment officer at 3D Asset Management, and whose firm invests in the PowerShares Variable Rate Preferred Portfolio (VRP), also notes that “a combination of declining credit spreads, particularly among financial issuers that dominate the preferred indices, as well as lower duration due to [VRP’s] holdings in floating-rate and hybrid issues” are other reasons to allocate to the segment.

The majority of the preferred segment is floating rate—a key feature that’s increasingly beneficial and attractive to investors as interest rates rise. The Federal Reserve just this month raised rates again.

VRP, which is up 4.5% year-to-date, has a unique design that holds floating-rate and variable-rate preferred stocks and/or hybrid securities with similar characteristics. According to ETF.com data, these floating-rate preferreds link dividends to a reference benchmark rate plus a fixed spread. While variable rate preferreds have a fixed dividend initially for a period of time, but later will turn into a floating-rate structure. VRP combines both.

“The self-adjusting nature of the dividends mitigates duration risk, so VRP can be a nice addition to an income portfolio to position for rising rates,” our research says.

Charts courtesy of StockCharts.com

VRP has $1.2 billion in assets, making it one of the largest in the preferred ETF segment. For comparison, IPFF has seen its asset base vary, and it currently has only about $62 million in assets under management.

The biggest in the space is PFF, with $17 billion in assets. PFF tracks an index of preferred stock traded on the NYSE and Nasdaq. Stocks are selected by rules-based, proprietary methods and weighted by modified market cap. The fund invests in preferreds regardless of their credit rating, “providing a broad and diversified portfolio,” according to ETF.com data.

Contact Cinthia Murphy at [email protected]