Preferred stocks offer investors the opportunity to obtain higher yields than bonds with an investment that carries less risk than common stock, and that is essentially a sort of hybrid between a debt security investment and an equity investment. Preferred stock dividends are fixed, and come first in priority ahead of common stock dividends. Also, preferred stocks are often appealing to higher income investors because the dividends are most commonly qualified dividends that are therefore taxed at a substantially lower rate than ordinary interest income.
ETFs offer an easy means of obtaining exposure to a basket of preferred stocks. Although some preferred stocks are convertible to common stock, the majority of ETFs hold mostly non-convertible preferred stock issues. A preferred stock ETF provides investors with diversification in preferred stocks, and usually involves significantly lower trading costs than buying individual preferred stocks, many of which have very low trading volume and liquidity.
iShares US Preferred Stock ETF
The iShares US Preferred Stock ETF was launched by BlackRock in 2007, and as of April 19, 2016, was overwhelmingly the most widely held preferred stock ETF, with $14.7 billion in total assets under management (AUM). This ETF tracks the benchmark market cap weighted S&P U.S. Preferred Stock Index, which is composed of preferred stocks listed on the New York Stock Exchange (NYSE) or NASDAQ exchange (this also includes preferred stocks traded on exchanges such as the NYSEARCA and the NASDAQ Select Market). In addition to holding the stocks contained in the underlying index, the fund may also invest in other securities, futures contracts, options or swaps that the fund manager determines will help the fund to most accurately track the index. Financial sector stocks dominate the portfolio, accounting for 82% of the fund's holdings. The fund's top three holdings are Allergan Plc Preferred Stock 03/18 5.5% (NYSE: AGN-PA), HSBC Holdings Pfd (NYSE: HSBC-PA) and Barclays Bank PLC (NYSE: BCS-PD).
With the fund's nearly 300 holdings, no single stock accounts for much more than 2% of the total portfolio. The portfolio turnover ratio is a relatively low 13%.
The fund's expense ratio is 0.47%, below the preferred stock category average 0.55%. The 12-month yield is 5.79%. The fund's five-year average annualized return is 6.03%, slightly underperforming the category average of 6.69%. As of April 19, 2016, the fund was up 1.24% year to date (YTD), though it still underperformed the category average of 2.23%.
PowerShares Preferred ETF
Invesco PowerShares launched the PowerShares Preferred ETF in 2008. This is the second most widely held ETF in the preferred stock category, with $3.7 billion in total assets. This ETF tracks the market-cap-weighted Bank of America Merrill Lynch Core Plus Fixed Rate Preferred Securities Index, an index designed to mirror the overall market performance of U.S. dollar-denominated preferred securities. The fund holds both U.S. domestic securities as well as foreign preferred stocks in the form of American Depositary Receipts (ADR). Financial stocks again predominate, making up 85% of the portfolio assets in a fund with more than 200 total holdings. The top three holdings are Barclays Bank PLC, HSBC Holdings Pfd and Wells Fargo & Company, San Francisco Ca Pfd (NYSE: WFC-PN). The portfolio turnover ratio is 12%.
The expense ratio for the PowerShares Preferred ETF is 0.50%, below the preferred stock category average 0.55%. The fund's 12-month yield is 5.85%. The five-year average annualized return is 7.34%, outperforming the category average. On April 19, 2016, the fund was up 1.18% YTD, which still underperformed compared to the category average of 2.23%.
Comparing PFF and PGX
Although the performance of these funds in terms of yield and YTD returns is very similar, and there is little difference between the expense ratios, the PowerShares Preferred ETF holds the edge based on its five-year average annualized return. A more exhaustive look at the return history of the two funds also shows it holding the advantage, with a three-year average annualized return of 6.16%, compared to 4.87% for the iShares US Preferred Stock ETF, and a one-year return of 6.05%, which is substantially higher than the iShares ETF's return of 2.91%.