Could Preferred Stock ETFs Be the Secret to Stable Income?

Income-based investors often devote a large part of their securities research time looking at bonds. dividend stocks, REITs, and midstream companies. For those with less bandwidth to devote to individual securities, comparing ETFs that hold those asset classes is an easier entryway to determine which ones fit subjective requirements.

Often forgotten from the checklist of income asset class considerations are preferred stocks. 

Categorized as equity by FASB but concurrently a reliable income source with 5% – 7% average APY, preferred stocks or their ETFs can very well be the missing component to a portfolio.

Preferred Stock – A Chimera Security

Like the mythical chimera, which has parts of different creatures, Preferred Stocks are hybrids that are part bond and part stock.

The movie Wall Street (1987) showcased an iconic, Academy Award-winning performance by Michael Douglas as multimillionaire corporate raider Gordon Gekko. Douglas captured much of the Wall Street vernacular in many of his office scenes, wheeling and dealing on the phone and barking instructions to traders, advisors, competitors, and underlings. 

Director and screenwriter Oliver Stone gave the Gekko character the bulk of the movie’s most memorable lines. One of Gekko’s funnier quotes pithily sums up his attitude towards analysts:

“I loved it at 40; It’s an insult at 50.  Their analysts don’t know preferred stock from livestock.”

The quote points out two things: 1) Gekko has disdain for a firm’s analysts and their price recommendations, comparing their lack of financial acumen to the clueless man on the street; 2) Preferred stock is an asset class that professionals and investors should both know in sufficient detail, since it has qualities and properties that can be strategically helpful to portfolios, under the proper circumstances.

Gekko’s analogy reference to livestock is both derogatory as well as relevant: Preferred Stock can be likened to the chimera of Greek mythology, since it has contains a mix of features that are more closely identified with bonds, but also contains equity properties 

When compared to bonds, Preferred Stocks share these characteristics:

• A par value (typically $25 per share)
• A fixed yield (average between 5% – 7% annually)
• Moodys, S&P, and Fitch credit ratings
• Call risk – similarly to municipal bonds some preferred stocks may be subject to call redemptions from the issuer on or after specified future dates
• The inverse price to yield ratio is comparable to bonds when interest rates fluctuate
• No voting rights

When compared to common stock, Preferred stock has these similarities:

• Trades on NYSE or NASDAQ
• Categorized as equity for accounting purposes, according to FASB (unless a call is mandatory)
• Ordinarily perpetual, i.e., with no specified maturity
• Preferred stock shareholders are second to last behind all bondholders and other creditors in the event of a corporate liquidation; right ahead of common shareholders, who are last. 

One advantage that preferred stocks have may be of interest to income investors with tax sensitivities: preferred stock dividends are usually considered to be qualified dividends.  As such, they are taxed as capital gains, rather than as income. 

While preferred stocks are a useful tool, one of their limitations is that the industrial sectors that issue preferred stocks tend to be in more traditional ones: financial, energy, transportation, utilities, and heavy manufacturing. The odds of finding AI technology or biotech preferreds are considerably much lower. 

Preferred Stock ETFs

Preferred stock ETFs can be a useful income component to a portfolio.

As one would expect, Preferred Stock ETFs are available from the usual big issuer financial firms, such as BlackRock, VanEck, and others. Some of the more popular ones worthy of consideration are: 

iShares Preferred and Income Securities ETF (NASDAQ: PFF)

Invesco Preferred ETF (NYSE: PGX) 

First Trust Preferred Securities and Income ETF (NYSE: FPE)

(statistics based on market price at the time of this writing)