It’s common these days for personal finance gurus, financial advisors, and, of course, mutual fund company CEOs to lament the proliferating flavors of ETFs (exchange traded funds.) And I’d agree that we probably really don’t need an ETF that gives the owner three-times downside leverage to the price of oil, or one that specializes in an index of cyber-security stocks, or yet another ETF that slices and dices emerging markets according to some catchy set of initials.
But last I looked nobody was holding a gun to my head to make me buy any of these alternatives. And I more often than not these days find myself appreciating the ability to fine-tune exposure to a sector using the “tweaks” of an ETF.
Which is exactly the case for ETFs that invest in preferred stocks. These are vehicles designed to appeal to dividend income investors since preferred shares pay higher rates of dividends than do common shares. And, theoretically, they are less risky than a portfolio of common shares since preferred dividends get paid first and are less liable to be slashed by a company looking to preserve cash.
I say “theoretically” since not all preferred dividends look equally safe these days–investors and analysts are nervous right now about bad debt and cash flow at some banks with big exposure to the energy sector. And a cut in dividend isn’t the only potential source of risk to a portfolio of preferred stocks. For example, banks are big issuers of preferred shares and the financial sector has been one of the worst performers of 2016 what with the aforementioned risk of bad loans in the energy sector and the uncertain direction of the yield curve because of negative interest rates at most of the world’s biggest central banks and a conviction that the U.S. Federal Reserve isn’t going to raise interest rates in 2016 as expected earlier. Banks make more money when the yield curve sharpens. That was expected to take place in 2016; it hasn’t yet; and looks disappointingly less likely, the market has concluded, this year.
All of which makes the difference between the iShares U.S. Preferred Stock ETF (PFF) and the Market Vectors Preferred Securities ex-Financials ETF (PFXF) so exactly to the point. If you think financials are ready for rebound, then the iShares Preferred ETF is your choice. About 62% of the fund’s holdings are preferred shares in the financial sector and with a rebound you can expect to collect the ETF’s 5.82% yield and some appreciation as the financial sector recovers. If, on the other hand, you think problems in the financial sector have further to run, your choice would be the Market Vectors Preferred ex-Financials ETF, because the ETF, as it’s name says, eschews financials. The portfolio for this ETF holds preferred shares from the likes of Tyson Foods, ArcelorMittal, Alcoa, and United Technologies rather than the preferred shares from HSBC, Ally Financial, Barclays, Wells Fargo, and Citigroup that make up the top five holdings at iShares Preferred. The biggest sector weightings for the Market Vectors Preferred ETF are in real estate investment trusts (35%), electric utilities (26%) and telecom (10%.)
The yield on the Market Vectors ETF is a little higher at 5.97% versus 5.82% (as of January 31) and the risk, in my estimation, is a little lower. (Fees are slightly higher at Market Vectors at 0.53% versus 0.47%.) I added the Market Vectors Preferred Securities Ex-Financias ETF to my dividend income portfolio on February 23 at the closing price at day of $19.26.