With stocks suffering the challenges of Dante's Inferno these days, and investors fleeing all kinds of risky investments, maybe it's time to consider other alternatives for clients' portfolios. Preferred ETFs and preferred mutual funds, unheard of a few years ago, may well be worth a look.
True, some advisors won't touch them. For one thing, most preferred ETFs and funds are heavily anchored in financial stocks, which have been whipsawed over the last few years. Indeed, to date most issuers of preferred stock have been financial firms.
Their stocks have mostly withered lately. "Preferred stock indices (not individual preferred stocks) cratered up to 60% during the subprime crisis," observes Louis Kokernak, CFA, CFP, a principal at Haven Financial Advisors in Austin, Texas, who avoids the space.
Even so, for all their risks, preferred ETFs and preferred funds offer plenty of benefits on the upside: high yields, good liquidity and diversification. On the ETF side, they offer lower costs.
Ultimately, choosing the right type for clients may well depend on whether you favor active or passive management.
Money has been seeping into ETFs and hemorrhaging out of mutual funds these days. Morningstar analysts agree that ETFs have been popular with investors, and Samuel Lee, an ETF analyst there, notes that some preferred ETFs such as the iShares Preferred Stock Index (PFF), managed by BlackRock Inc., have an extremely high yield. Plus, ETFs make asset allocation easier, he says.
Preferred ETFs occupy a relatively small component of the $1 trillion-plus ETF market. Generally, preferred ETFs are benchmarked to various indexes and, like their fund counterparts, tend to focus mostly on financial preferred stocks.
In general, preferred ETFs hold all the advantages of ETFs. They have a lower relative expense ratio that is often half that of a mutual fund, since the ETFs are not actively managed. ETFs also have flexibility: They can be bought and sold at any time during the trading day, unlike mutual funds. They offer tax efficiency because they generate low capital gains. And they offer more transparency-you always know exactly what the holdings are.
Says Kevin D. Mahn, chief investment officer of Hennion & Walsh Asset Management in Parsippany, N.J.: "You get more predictability in terms of returns, as the majority [of ETFs] are designed to track an underlying index. They're not trying to beat anything or actively manage the index; they are a passive means by which to gain exposure to a preferred stock index."
Mahn, who pens a quarterly newsletter and co-authored a book on ETFs, believes the ETF route is "more targeted and accessible" than mutual fund exposure to preferred securities.
BlackRock's iShares And Invesco's PowerShares
The two big preferred ETF powerhouses are BlackRock and Invesco. Each has its adherents.
BlackRock's iShares line of ETFs is the larger in assets under management ($620 billion) and products. Its preferred ETF product, the iShares S&P U.S. Preferred Stock Index fund (PFF), tracks the S&P U.S. Preferred Stock Index, which is 84% weighted in financials.