Choosing to invest in preferred stock exchange-traded funds or bond ETFs should be based on the current economic environment as well as your investment strategy. If you’re looking for high yield, consider preferred stock ETFs. This is especially the case in low interest rate environments. As far as quality goes, a lot will depend on the ETF, but in general, preferred stock ETFs are seen as better than common stock but junior to corporate bonds. Preferred stock ETFs are higher quality than common stock ETFs because you will have priority over common shareholders for dividends and claims on assets. However, preferred stock ETFs usually under perform equity ETFs during bull markets. As far as not being as high quality as bonds, this simply pertains to risk.
Most bond ETFs offer a diversified portfolio of bonds, excellent liquidity and low expenses. One of the bond ETFs covered below should clearly offer the most long-term potential regardless of how the broader stock market is performing. (For more, see: Exchange-Traded Funds: Introduction.)
Preferred Stock ETFs
Let’s start with a quick look at two of the most popular preferred stock ETFs.
Invesco Preferred ETF (PGX)
Tracks the ICE BofAML Core Plus Fixed Rate Preferred Securities Index
- Total Assets: $4.34 billion
- Volume: 230,000
- Expenses: 0.51%
- 12-month Yield: 5.98%
- Inception Date: Jan. 31, 2008
- 1-Year Performance: -3.54%
iShares US Preferred Stock (PFF) ETF
Tracks the S&P U.S. Preferred Stock Index. (For more, see: A Primer on Preferred Stocks.)
- Total Assets: $13.5 billion
- Volume: 1,584,000
- Expenses: 0.46%
- 12-month Yield: 5.79%
- Inception Date: March 26, 2007
- 1-Year Performance: -3.15%
The appreciation and high yield for the two preferred stock ETFs above might be tempting, but when interest rates increase they’re not likely to perform as well. Both also performed poorly during the financial crisis, demonstrating a lack of resiliency.
Preferred Stock ETFs Vs Bond ETFs
SPDR Bloomberg Barclays High Yield Bond ETF (JNK)
Tracks the Bloomberg Barclays High Yield Very Liquid Index.(For more, see: Is the JNK ETF a Good Investment?)
- Total Assets: $6.63 billion
- Volume: 14,000,000
- Expenses: 0.40%
- 12-month Yield: 5.69%
- Inception Date: Nov. 28, 2007
- 1-Year Performance: -0.97%
iShares 20+ Year Treasury Bond (TLT)
Tracks the Bloomberg Barclays Long U.S. Treasury Index.
- Total Assets: $8.28 billion
- Volume: 5,300,000
- Expenses: 0.15%
- 12-month Yield: 2.45%
- Inception Date: July 22, 2002
- 1-Year Performance: -7.05%
This is one of many situations where yield or lack of it can be deceiving. Most investors chase high yield, not realizing that they’re often putting themselves more at risk for depreciation. A high yield doesn’t mean anything if an ETF’s shares slide. That’s the beauty of TLT. The yield might not be extraordinary (still relatively generous), and it tends to appreciate during difficult times because big money rushes to safety.
The Bottom Line
Preferred stock ETFs are more appealing in low interest rate environments thanks to high yield, but they’re not likely to appreciate as much as ETFs tracking common shares during bull markets. Bond ETFs have a reputation for offering more safety, but it depends on the bond ETF. For instance, JNK offers high yield, but it’s not a place be if defaults are more likely due to poor economic conditions. TLT might not offer as much yield, but it offers resiliency and the low expense ratio is an added bonus.