Popular Preferred Share Funds Paying 4-5%: 1 to Buy, 2 to Sell

Brett Owens, Chief Investment Strategist
Updated: March 7, 2017

One question I field all the time is, “Should I own preferred stocks?” and my answer is always the same: “Yes, yes and yes.”

But after that, things get tricky.

When most investors think of investing in preferred stocks, they think about popular funds like the iShares U.S. Preferred Stock ETF (PFF) or the PowerShares Preferred Portfolio (PGX). But despite yields near 6%, these mainstream preferred stock funds are the wrong way to go. Instead, I suggest you take my lead and look at outside-the-box preferred-stock options like the three high-yield picks I have in store for you today.

But first – why preferred stocks?

Preferreds are high-yield stocks that are often referred to as “hybrids” because they’re not common stock, and they’re not debt … but they borrow features from both. So while a preferred stock trades on an exchange (like common stocks), it tends to trade around a par value (like bonds). And while preferred stocks offer fixed regular payouts (like bonds), investors really have no rights against the company if it stops paying out dividends (like common stocks).

That risk explains why preferred stocks, despite being extremely stable investments, yield in the realm of 6% to 7%. Kevin Lynyak, Head of Trading for Morgan Stanley Wealth Management Capital Markets, explained the payoff for investors in a 2016 research note:

“Preferred Stock investors receive incremental yield versus senior debt for assuming subordination risk, along with a tax advantage on qualified dividends versus ordinary income on bonds.”

High yields and favorable tax rules? That’s something every income investor can get behind!

As I said before, though, I don’t believe basic preferred index funds like PFF and PGX are the way to go. Instead, I want to look at some more targeted picks to see if we can find the right high-yield plays for you.

iShares International Preferred Stock ETF (IPFF)

Dividend Yield: 4.7%
Expenses: 0.55%

What’s more outside the box than looking outside the country?

The iShares International Preferred Stock ETF (IPFF) is the only ETF that targets international preferred shares, and that alone makes it stand out.

No, really. That’s all that really makes IPFF stand out.

The IPFF’s international portfolio is limited to just seven countries. Worse, that includes a 78.5% weight in preferred stocks from Canadian companies like TransCanada (TRP) and Toronto-Dominion Bank (TD) and an 11.5% weight in the United Kingdom.

If you’ve ever wanted to say you’re invested somehow in the Bailiwick of Guernsey, the IPFF is the fund for you.

But while the idea behind an international preferred stock ETF is enticing, a sub-5% dividend yield (lagging most other preferred ETFs) and hyper-concentrated country weights aren’t my idea of a smart high-yield buy.

iShares’ IPFF Can’t Hang With the Big Boys

VanEck Vectors Preferred Securities ex Financials ETF (PFXF)

Dividend Yield: 5.6%
Expenses: 0.41%

The VanEck Vectors Preferred Securities ex Financials ETF (PFXF) is a long name with a short, simple premise: It’s preferred stocks without the financials.

See, most preferred stock funds (like the PFF and PGX) are heavy in U.S. financial stocks, including banks and insurance companies. But those very companies were the hardest-hit during the 2008-09 financial crisis, and that included their preferred shares. The PFF, in fact, lost nearly 70% from its 2007 highs through the 2009 lows.

VanEck’s PFXF seeks to shield investors from that kind of hit, investing only in preferred securities from non-financial companies. The portfolio instead is rife with the preferreds of electric utilities, real estate investment trusts (REITs) and telcos, among other areas of the market.

But PFXF boasts a few advantages outside of its diversification away from financial preferred stocks. Specifically, PFXF undercuts the likes of PFF and PGX with a small 0.41% expense ratio, and at 5.6%, you’re right in the same ballpark with traditional preferred funds.

VanEck’s PFXF Delivers Serious Returns Thanks to Serious Yields

PowerShares Variable Rate Preferred Portfolio (VRP)

Dividend Yield: 4.9%
Expenses: 0.5%

One of my biggest criticisms with PFF and PGX is that they don’t emphasize floating-rate preferred stocks enough. That’s not the case with the PowerShares Variable Rate Preferred Portfolio (VRP).

The VRP, which invests at least 90% of its total assets in securities within a Wells Fargo floating-rate preferred-stock index, is a hedge against rising interest rates. Floating-rate preferred stocks tend to be even more stable than regular preferred stocks because their yields are adjusted as interest rates move, which in turn ensures that the preferreds continue to trade close to par.

Most floating-rate preferred stocks come from the financial sector, which explains the VRP’s nearly 80% weight in the sector. It also has significant weight in energy and utilities.

However, this relatively new fund that came to life in mid-2015 is currently so weak on yield that it’s not worth recommending, especially because any rate hikes in the near future are likely to be minimal.

PowerShares’ VRP Is Too Light on Yield

The Retirement Portfolio You NEVER Have to Touch!

Yes, floating-rate preferred stocks are a fantastic idea, but don’t settle for the lousy sub-5% yield of the VRP. Your money is far better off in the 8%-plus winners I’ve featured in my “No Withdrawal” retirement portfolio.

The problem with most retirement picks is that they’re designed to merely get you to retirement. So you build up your nest egg, say goodbye to the workplace … and then what? Your vaulted blue-chips only yield 3%, maybe 4%, meaning even if you have a million-dollar nest egg, you’re only raking in $30,000, $40,000 a year. And that means you could quickly find yourself clawing away at the nest egg to make ends meet.

Do not settle for that kind of retirement!

My “No Withdrawal” retirement portfolio is a set of picks that generate 6%, 7%, 8% and even higher so you can live off dividend income alone and never touch your nest egg. In fact, this portfolio is designed to even grow your nest egg thanks to a few holdings that offer 7% to 15% upside!

What makes this portfolio so effective is that it picks and chooses from all corners of the market. Preferred stocks, REITs, closed-end funds … this set of high-yield stock picks selects from the best holdings across the high-yield spectrum.

Don’t spend your retirement calculating and recalculating how many years your nest egg has left, leaving you with nothing but your Social Security check. Instead, collect regular dividend checks that will pay the bills, finance your vacations and even let you spoil your family.

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