Preferred stock investing just isn't what it used to be. Once a relatively common way for companies to raise money, the expansion of the corporate credit market has largely consigned preferred stock to private/venture-stage companies and financial corporations like banks. That said, preferred stock still boasts some very appealing attributes; this asset class is known for often exhibiting volatility levels comparable to fixed income, while marrying a steady income stream with the potential for capital appreciation. For investors looking to hold a portfolio of preferred stocks, the S&P U.S. Preferred Stock Fund (PFF) is an option to consider .

In A Nutshell

PFF, launched in March of 2007, is intended to replicate the performance of the S&P U.S. Preferred Stock Index. This fund recently held 267 securities and boasted a net asset value in excess of $10 billion. This ETF has solid daily liquidity and has always offered a yield superior to the S&P 500 during its existence .

While this fund is designed to hold a large number of preferred stocks, it is not as diversified as the number of securities may suggest. Few non-finance companies issue preferred stock these days, which leaves this fund holding over three-quarters of total assets in various types of financial companies, including: banks, insurance, real estate, "diversified financials" and so on.

What Makes PFF Unique

Of the eight preferred stock ETFs currently available, PFF is the largest and most diversified by a wide margin. PFF holds 267 positions, nearly double Wells Fargo Preferred Stock ETF (PSK), the nearest alternative. Its net asset value is more than double that of the other preferred stock ETFs combined. This fund is also unusual in that it is quite balanced, with less than one-fifth of its assets invested in its top ten holdings. Furthermore, PFF offers this scale and diversification without compromising yield .

It is also worth noting that PFF pays out distributions on a monthly basis, but the amounts do vary from month to month.

How It Fits

PFF can fit into numerous portfolios. Investors who need a revenue stream from their portfolios can use PFF as a core holding to generate some of that income, particularly as the fund's large and diverse portfolio reduces individual company risk and mitigates the impact of early redemptions/repurchases .

Although this fund is not well-suited as a trading instrument, it could be useful to more aggressive investors looking to implement a barbell strategy. It's also worth noting that PFF has arelativelylow beta, making it a worthwhile option for hedging or diversifying market risk.

What It'll Cost You

With an expense ratio of 0.48%, PFF falls in the middle its category's cost spectrum considering a range of 0.35% to 0.60%. Commission-free trading is not available for this fund at this time. Because of this fund's income orientation, investors should expect to receive taxable distributions every year.

Under The Hood

As mentioned, this fund is dedicated to investing in preferred stocks. In today's market that means that this fund is investing extensively in the financials sector. Nearly half of the fund's holdings are classified as "diversified financial", with another quarter of total assets going to banks, along with minimal exposure to insurance and real estate companies .

Just under one-fifth of the fund's assets are invested in the top ten holdings, while the fund holds 267 positions in total. This makes PFF a relatively well-balanced fund for this space. This fund also does offer some international diversification, as the majority of the top ten holdings are based outside the United States. From a geographic perspective, this fund features allocations to U.K.-based holdings and companies from Germany, Netherlands, South Africa, Spain and Switzerland.

Yield, Volatility and Performance

PFF has distributions paid out on a monthly basis, making it an appealing instrument for income-hungry investors.

Generally speaking, PFF is less volatile than the broader stock market; however, investors should be aware that this fund is somewhat more volatile than investment-grade bond funds.Investors should also note that preferred stocks are highly sensitive to interest rates, so this fund's volatility could increase substantially during a period of rising rates .

As this fund launched in the midst of the recent financial crisis, it's not altogether surprising that its first two years of performance were not good. The fund rebounded strongly in 2009 (+39%) and continued that performance in 2010 (+14%), before giving back some gains in 2011 (-2%).

Other Options

The ETFs profiled below offergenerallysimilar exposure as PFF, although there are a number of distinguishingcharacteristicsto each one:

  • Barclays Capital Convertible Bond ETF (CWB):This is the only fund cheaper than PFF in thepreferredspace that also offers reasonable diversity and liquidity.
  • Market Vectors Preferred Securities ex-Financials ETF (PFXF): This offering excludes financial companies, but is far more concentrated in its top ten holdings than PFF.
  • Global X Canada Preferred ETF (CNPF): This ETFoffers investors the chance to geographically diversify while still retaining a risk/return profile that is generally similar to domestic preferred securities.

Disclosure: No positions at time of writing.

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