Preferred Stock ETFs: Steady Income In Uncertain Times

 | Oct 22, 2020 04:51

Looking for steady income? Preferred stocks are one of many instrument types that can help.

Today, we will look at the characteristics of preferred stocks and two exchange-traded funds (ETFs) to gain exposure.

It is important to note that preferred securities may have different characteristics in different countries. Our discussion centers around those issued in the US.

h2 Preferred Stock: Advantages And Drawbacks/h2

Preferred shares have characteristics of bonds, which pay a fixed income and stocks, which represent ownership in a company. Holders, who typically buy them for income and not necessarily growth, are entitled to dividend payments on a set schedule, which resemble bond interest payments.

The banking sector is currently the largest segment of the preferred universe in the US as many banks issued preferred stocks following the subprime crisis and the economic contraction over a decade ago. This is one of the best ways for banks to meet the higher capital requirements imposed by regulators.

While company earnings do not have much effect on the price of preferred stocks, interest rates and credit ratings are important factors.

In bankruptcy and liquidation, preferred stockholders have priority over common stockholders. This higher claim on a company's assets is part of the reason for the term "preferred."

But they stand behind creditors, so preferred shareholders get paid only if there is money left after all senior creditors have been paid off. Due to this subordination risk, preferred stocks pay higher rates than the same corporate entity's bonds.

Another reason for the higher dividend rate: preferred stocks are callable, so although preferred stocks would not have a maturity date, they are typically issued with a five-year call provision. If interest rates fall, the preferred stocks could trade at a premium and could easily be called (redeemed) by the issuer at par.

For instance, if the callable preferred shares on the market have a 5% dividend when interest rates fall to 1%, the issuer can purchase outstanding shares. Then it reissues new preferred stocks at a lower dividend rate. Such a move helps the business decrease the cost of capital. However, the original shareholder is disadvantaged.

On a final note, there may be some tax benefits to preferred stock dividends for US-based investors, who may want to consult their accountants or financial advisors.

With that in mind, here are two preferred stock ETFs that enable investors to buy a portfolio of preferred shares:

h2 1. Invesco Preferred ETF
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  • Current Price: $14.73
  • 52 Week Range: $9.71 - $15.28
  • Dividend Yield: 5.04%
  • Expense Ratio: 0.50%
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The Invesco Preferred ETF (NYSE:PGX) provides exposure to fixed-rate US dollar-denominated preferred securities issued in the US. The fund started trading in 2008 and is rebalanced monthly.