What You Might Not Know About Preferred Stock ETFs & The Financial Sector (PSK, PFF, PGX, PGF, PFXF)

Ron Rowland: Preferred stocks are an important tool for yield-hungry investors. And these days — with even long-term interest rates at historic lows — we’re all looking for income.

What are preferred stocks and how do they help? Today I’ll help you understand, and I’ll give you some important questions to ask before you buy any preferred stock ETF.

Common or Preferred?

You know how common stocks work. Each share represents partial ownership of a company. In some cases, shareholders receive cash dividend payments.

Preferred stock investors get paid first.
Preferred stock investors get paid first.

Preferred stocks are stocks, too, but they’re in a different class from a company’s common shares. They are first in line to receive any dividends — which makes them very attractive to investors who want current income. You can read more in “Move to the Front of the Line with Preferred Stock ETFs.”

As I said in that column, most preferred stocks are issued by financial services companies. This gives preferred stock ETFs a natural tilt toward the financial sector.

It’s a big tilt, too. Here are the recent allocations for some of the group’s top ETFs:

  • SPDR Wells Fargo Preferred Stock ETF (NYSEARCA:PSK) has 81.1 percent of its portfolio in banks, insurance, real estate and other financial sector companies.
  • For iShares S&P U.S. Preferred Stock Index Fund (NYSEARCA:PFF), total financial sector exposure is 83.3 percent!
  • PowerShares Preferred Portfolio (NYSEARCA:PGX) is even more dependent on financials with a 91.6 percent weighting!

One ETF beats the others, though: PowerShares Financial Preferred Portfolio (NYSEARCA:PGF) has 99 percent financials exposure! It would be 100 percent, but they need to keep a little cash on hand for expenses.

Amusing, isn’t it? The same ETF sponsor offers two different preferred stock ETFs that are practically identical. If the 91.6 percent financials slice of PGX just isn’t enough, you can go all-in with PGF. PowerShares has you covered.

As far as I can tell, until just recently every preferred stock ETF had at least 70 percent exposure to the financial sector. This is, of course, the very sector that almost imploded on itself in 2008 and had to be bailed out. So I don’t blame investors who avoid it.

What If You Don’t “Prefer” Financials?

I said almost a year ago, in the article linked above …

“I would love to see a ‘preferred stocks ex-financials’ ETF, but I’m not aware of one.”

… so I was excited to hear about Market Vectors Preferred Securities ex Financials ETF (NYSEARCA:PFXF). This new fund left the launch pad July 17 — just last week. (“Ex” means “without any” in trading jargon.)

PFXF sounds like an answered prayer. Preferred securities? Check. Ex-Financials? Check again. Just what I was looking for.

Then I looked deeper and found a little problem. PFXF follows an index, developed by Wells Fargo, that defines “Financial” in an unusual way.

According to the index PFXF follows, this was not a financial company.
According to the index PFXF follows, this was not a financial company.

Under their definition, insurance companies and real estate investment trusts are not “financial” stocks. With that, PFXF gives 37 percent to preferred securities issued by REITs and insurers. And since those aren’t “financial” companies in their view, they can still name the ETF “ex-financials.”

Remember AIG, the insurance company that collapsed in 2008 and nearly brought the whole economy down with it? Insurers today are huge players in the financial markets. Calling them something else, as Wells Fargo and Market Vectors do, does not make them so.

Now, 37 percent in financials is certainly better than the 70, 80, and 90+ percent exposure found in other preferred stock ETFs. If you want preferred stocks in an ETF while minimizing your financials exposure, PFXF is a good candidate. It is not however, “ex-Financials” as all other index providers define the term.

With that reservation, I’m still glad to see PFXF join the list. It’s brand new and will need some time to prove itself. Preferred stock ETF investors should put PFXF on the watch list.

Best wishes,

Written By Ron Rowland From Money And Markets

Money and Markets (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss  along with Nilus Mattive, Claus Vogt, Ron Rowland, Michael Larson. To avoid conflicts of interest, Weiss Research and its  staff  do not hold positions in companies recommended inMaM, nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not  guaranteed. Performance returns cited are derived from our best  estimates but must be considered hypothetical in as much as we do not  track the actual prices investors pay or receive. Regular contributors and staff include Andrea Baumwald, John Burke, Marci Campbell, Selene  Ceballo, Amber Dakar, Maryellen Murphy, Jennifer Newman-Amos, Adam  Shafer, Julie Trudeau, Jill Umiker, Leslie Underwood and Michelle  Zausnig.

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