Inside First Trust's New Preferred Securities ETF (FPE) - ETF News And Commentary

By Zacks | February 14, 2013 AAA

Although markets continue to perform well, income-paying choices remain favorites of many investors. Considering that many are starved for current income thanks to extremely low yields, it isn't hard to see why that these types of securities remain popular in a number of portfolios, even with the market surge.   While high yielding sectors like consumer staples, utilities, and financials, remain at the forefront of investors' minds, some have begun to expand into potentially higher yielding but exotic securities as well. These include BDCs, MLPs, and even preferred securities, all of which have gained in exposure and popularity in recent years.

Still, preferred securities are often overlooked in favor of BDCs and MLPs which have really taken off with investors as of late. However, this may be to investors' detriment as these preferred shares can offer up some exciting benefits to those willing to give the space another look.

That is because preferred stocks generally have similar tax treatments as 'regular' common stock - simplifying the process - while they are ahead of these shares in a liquidation line. Although this means that they usually don't get voting rights, they are often less volatile then their common stock counterparts and generally pay juicy yields as well (read Are Preferred Stock ETFs Worth The Risk?).

Many investors, however, are not comfortable selecting individual preferred stocks, so an ETF approach may be the way to go for most. There are plenty of choices in this corner of the ETF world, with several types of exposure offered, with one exception; active management.

Strangely there wasn't a single actively managed preferred securities ETFs out on the market, despite the relatively illiquid space, and the lack of investor knowledge about preferred securities. That is no longer the case anymore though, as First Trust has filled the void with its Preferred Securities and Income ETF (FPE)

FPE in Focus

This new active ETF looks to provide investors with a robust level of current income. The focus will be on preferred securities, while it will also hold income-producing debt securities including corporates, high yields, and convertibles.

At time of writing, the portfolio consisted of about 80 companies with a very low concentration ratio for the top ten holdings. The industry profile is focused on financials though, as insurance, REITs, Commercial Banks, and Capital Markets, all account for at least 14.75% of the portfolio (see Three Overlooked High Yield ETFs).

Investors should also note that StoneBridge Advisors LLC is the sub-advisor to the fund, a company that specializes in preferred and hybrid securities. Their focus is on providing solid returns while limiting risk, so low volatility looks to be a theme in this preferred security ETF.

How does it fit in a portfolio?

FPE looks to be a solid choice for investors who want a great deal of current income, but a low level of volatility. It could also be a decent pick for investors who believe that BDCs and MLPs are overbid at this time, and that other corners of the financial world are better avenues for investment at this time.

The ETF could also be interesting for those who believe in active management and that the preferred stock segment is ripe for these types of techniques. The space is relatively underappreciated so FPE could be good for those who believe that a watchful eye of a manager can pick the correct funds in this relatively overlooked market (read Can You Beat These High Dividend ETFs?).

It may not be the best choice for cost-focused investors though, as a relatively steep 85 basis point cost does make it pretty expensive, although pretty much in line for actively managed 'exotic' products like this one.

Bid ask spreads may be a bit light initially too, so it probably isn't a great idea for traders, although one has to question the wisdom of short-term trading on such a static corner of the market anyway. 

Can it succeed?

Generally speaking, actively managed products haven't really been embraced by many in the ETF world. This is starting to change though as more of these funds are coming on the market, and opening up a variety of less liquid corners to everyday investors.

FPE will certainly have its hands full beyond the active management issue though, as the product compares extremely unfavorably on an expense ratio perspective and is the most expensive ETF in the category by a wide margin.

Furthermore, three funds, PGF, PGX, and PFF have more than $1 billion in total AUM so there are definitely some entrenched participants in the preferred security ETF world (see 3 Excellent ETFs with More than 4% Yield).

Even with these issues, FPE could see some decent inflows as it could be a high income choice in the space, something that investors have clearly embraced time and time again.  So, if FPE can achieve a high rate of income and reduce volatility, it could definitely see some solid interest, especially if it can justify its higher expense ratio to cost-conscious investors.

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