Best Preferred Stock ETF: A Comprehensive Guide for Income Investors

Discover the best preferred stock ETFs for generating reliable passive income. This guide explores top-rated funds like PFF, PFFD, and PGX, analyzing their yields, risks, and how they fit into a di...

2024-09-04 09:24:00

By Alex Carter

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The best preferred stock ETF options offer investors a unique middle ground between the stability of bonds and the growth potential of common stocks. For those seeking high dividend yields in the U.S. stock market, preferred stock Exchange-Traded Funds (ETFs) have become a cornerstone of income-generating portfolios. These hybrid securities provide a fixed stream of income, often ranging from 5% to 7%, making them highly attractive during periods of market volatility.

Understanding Preferred Stock as a Hybrid Asset

Preferred stock is often described as a "hybrid" because it shares characteristics with both debt and equity. Like a bond, it pays a fixed dividend and has a par value; like a stock, it represents ownership in a company and trades on major exchanges.

Characteristics of Preferred Shares

Preferred shareholders occupy a specific niche in a company's capital structure. They generally do not have voting rights, unlike common shareholders. However, they possess a higher claim on assets and earnings. In the event of a company's liquidation, preferred stockholders are paid after bondholders but before common stockholders. This seniority provides a layer of safety for conservative investors.

Dividend Structures

One of the primary draws of the best preferred stock ETFs is the dividend structure. Most preferred dividends are "qualified," meaning they are taxed at the lower long-term capital gains rate rather than as ordinary income. Additionally, many preferred shares are "cumulative," signifying that if a company misses a dividend payment, it must pay all arrears to preferred holders before any dividends can be paid to common shareholders.

Top-Rated Preferred Stock ETFs by Market Share and Performance

When searching for the best preferred stock ETF, investors typically look at liquidity, expense ratios, and the underlying quality of the issuing companies. As of late 2024, several funds dominate the landscape.

iShares Preferred and Income Securities ETF (PFF)

PFF is the titan of the industry, being the largest and most liquid preferred stock ETF on the market. It primarily tracks an index of U.S.-listed preferred stocks, with a heavy concentration in the financial sector. Because of its massive scale, it offers excellent intraday liquidity for traders and long-term investors alike.

Global X U.S. Preferred ETF (PFFD)

For cost-conscious investors, PFFD is often cited as the best preferred stock ETF due to its low expense ratio. By keeping management fees at a minimum, PFFD allows a larger portion of the dividend yield to reach the investor's pocket, making it a highly efficient vehicle for long-term compounding.

Invesco Preferred ETF (PGX)

PGX focuses on fixed-rate, investment-grade preferred securities. This fund is ideal for investors who prioritize credit quality and want to avoid the higher volatility associated with "junk" or sub-investment-grade preferred shares. It provides a steady stream of monthly distributions.

First Trust Preferred Securities and Income ETF (FPE)

Unlike the passive index funds mentioned above, FPE is an actively managed ETF. The fund managers have the flexibility to adjust holdings based on interest rate environments and credit trends. It often includes convertible debt and global preferred securities, providing broader diversification than standard domestic funds.

Selection Criteria for the "Best" ETF

Choosing the best preferred stock ETF requires more than just looking at the highest yield. Investors must evaluate several key metrics to ensure the fund aligns with their risk tolerance.

Expense Ratios

The expense ratio is the annual fee charged by the fund. In the preferred stock space, fees typically range from 0.20% to 0.85%. Over a decade of investing, a lower expense ratio can significantly increase total returns, especially in a fixed-income-heavy strategy.

SEC Yield vs. Distribution Yield

Investors should distinguish between the SEC yield (a standardized 30-day calculation based on the most recent dividends) and the distribution yield (the actual cash paid out over the past 12 months). The SEC yield often provides a more accurate reflection of current earning potential in a changing interest rate environment.

Credit Quality and Sector Concentration

Most preferred stock ETFs are heavily weighted toward the banking, insurance, and utility sectors. While these sectors are traditionally stable, high concentration means the ETF is sensitive to financial sector regulations and systemic risks. Checking the credit ratings (e.g., S&P or Moody’s) of the underlying holdings is essential.

Risks and Considerations

While preferred stocks offer higher yields than common stocks, they are not without risk. Understanding these nuances is critical for any portfolio manager.

Interest Rate Sensitivity

Preferred stocks have "duration risk," meaning their prices move inversely to interest rates. When interest rates rise, the fixed dividend of a preferred stock becomes less attractive, causing its price to drop. This makes the best preferred stock ETF options sensitive to Federal Reserve policy shifts.

Call Risk

Many preferred shares are "callable," meaning the issuer has the right to buy back the shares at par value after a certain date. If interest rates fall, companies may call their high-yielding preferred shares and reissue them at lower rates, limiting the capital appreciation potential for investors.

Credit Risk

In times of severe economic distress or banking crises, preferred dividends can be suspended. Unlike bond interest, which a company is legally obligated to pay to avoid default, preferred dividends can be deferred if the company’s board of directors deems it necessary to preserve capital.

Investment Strategies and Portfolio Role

Preferred stock ETFs serve as a powerful tool for income generation. They are frequently used as a supplement to traditional bond ladders or as a way to boost the yield of a dividend-growth portfolio.

Income Generation and Tax Advantages

Because many preferred dividends qualify for lower tax rates, they can be more tax-efficient than interest-bearing bonds in a taxable brokerage account. This makes them a preferred choice for high-net-worth individuals looking to maximize after-tax income.

Integrating Modern Assets

In today's evolving financial landscape, many investors are balancing traditional assets like preferred stocks with digital assets. While preferred stock ETFs provide steady cash flow, platforms like Bitget allow investors to explore the growth potential of cryptocurrencies. Just as one might diversify across different preferred stock sectors, using a secure exchange like Bitget to diversify into digital assets can help hedge against traditional market inflation.