Exchange-traded funds (ETFs) have gained immense popularity in recent years as a preferred investment option. With the introduction of Preferred ETFs, investors now have more options to diversify their portfolio and benefit from attractive yields. In this panel discussion-style post, we will discuss what Preferred ETFs are, how they work, and the benefits they offer to investors.
What are Preferred ETFs?
Preferred ETFs invest in preferred stocks that are issued by companies. These stocks usually pay fixed dividends, making them an attractive option for income-seeking investors. Unlike common stockholders who only receive dividends if a company makes profits after paying off debts and other obligations, preferred shareholders receive a fixed dividend payment regardless of whether the company earns profits or not.
How do Preferred ETFs work?
Preferred ETFs hold portfolios of preferred stocks issued by different companies across various sectors such as banking, finance, utilities, real estate investment trusts (REIT), and energy. The fund managers select these stocks based on their quality (credit rating), yield potential, and overall performance.
The value of a Preferred ETF is determined by its net asset value (NAV), which is calculated by dividing the total value of all assets held by the fund minus any liabilities it owes to creditors or bondholders. Investors can buy or sell shares in the fund through brokerage firms just like regular stocks.
Benefits of investing in Preferred ETFs
1) High Yield: As mentioned earlier, preferred shares typically offer higher yields than common shares due to their fixed dividend payments.
2) Stability: Investors who prefer less volatile investments than common equities may find comfort in adding some preferred shares to their portfolio since they tend to be less sensitive to market fluctuations.
3) Diversification: By investing in Preferred ETFs that track multiple issuers across industries with different credit ratings such as BBB-, BB+ etc., investors can achieve greater diversification compared with buying individual securities themselves.
4) Tax Benefits: Dividends paid by preferred stocks are usually taxed at a lower rate than those paid on common shares, resulting in greater after-tax returns for investors.
5) Liquidity: Preferred ETFs are highly liquid and can be bought or sold easily through brokerage firms throughout the trading day.
Preferred ETFs vs. Bonds
Preferred ETFs share some similarities with bonds. Both offer fixed income payments to investors, but there are several differences between them that investors should consider before making investment decisions:
1) Credit risk: Bondholders receive priority over preferred shareholders when it comes to repayment of debt obligations. If a company goes bankrupt, bondholders will get their money back first before preferred shareholders. This means bonds carry lower credit risk compared to preferred shares.
2) Yield Curve Risk: Bonds have a fixed maturity date, and investors who hold the bond until maturity receive their principal back as well as interest payments throughout the life of the bond. In contrast, Preferred ETF prices fluctuate based on market conditions and changes in interest rates thereby exposing buyers to yield curve risk which is not present in bonds.
How to choose a Preferred ETF
When selecting a Preferred ETF, here are some factors that you may want to consider:
1) Expense Ratio – The expense ratio represents how much it costs an investor annually to own the fund. Lower expenses mean higher returns for investors.
2) Yield – Investors looking for higher yields may prefer funds that focus on high-yielding securities such as REITs or financial institutions.
3) Diversification – Funds with diversified holdings across various sectors reduce concentration risk and help spread out risks among different issuers
4) Credit Quality – Funds with higher credit quality ratings tend to be less risky than those with lower ratings since they have better chances of meeting their debt obligations even during tough economic times.
Top Preferred ETFs:
Here are some top-performing Preferred ETFs according to Morningstar rankings (as of August 2021):
1) iShares Preferred and Income Securities ETF (PFF)
2) Invesco Preferred ETF (PGX)
3) Global X S&P 500 Quality Dividend ETF (QDIV)
Conclusion
Preferred ETFs offer investors a unique opportunity to diversify their portfolio while still maintaining high yields. Their fixed dividend payments, low volatility and tax benefits make them an attractive option for income-seeking investors looking to balance out their portfolios with less risky securities. As always, it’s important to do your own research before investing in any security or financial product and seek the advice of a professional if needed.