Investing in Preferred Stock ETFs: What You Need to Know

With yields on bonds and CDs so low as to almost be insulting, investors are finding themselves searching for income in places they might normally have never thought to look. 

I’ve written extensively about dividend paying stocks and about dividend-focused ETFs in particular.  Today, I’m going to cover an asset class that has historically been the domain of pension and endowment funds: preferred stock.

If you’re not entirely sure what preferred stock is, don’t feel bad.  Chances are good that your broker or financial advisor has never mentioned it to you, and you’re not going to read about them in the financial pages or hear about them on CNBC.

Preferred stock is not “stock” at all, at least in the way you are accustomed to thinking about it.  Preferreds are hybrid securities that behave more like bonds than common stocks.  Though the features vary from issue to issue, most preferreds fit the following description:

  1. They pay a high dividend that generally does not change over the life of the security, making it similar to bond interest.  This dividend is not “guaranteed,” though it generally has to be paid before common stock dividends can be paid.   
  2. Bondholder claims rank higher than preferred stockholders in both their regular interest payments and in assets in the event of liquidation, but preferred stockholders rank above common stockholders.
  3. Preferred stock carries no voting rights.
  4. Preferred stock can be converted to common stock under certain conditions.
  5. Preferred stock can often be callable at a given price at the company’s discretion.  Some preferred shares have fixed redemption dates, which are similar to a bond’s maturity date.
  6. Preferred stock is often cumulative, meaning that missed dividends have to be made up later.

When you research potential investments in preferred stock, you approach them differently than you would regular common stock.  For example, if you bought preferred shares rather than the common shares of General Motors ($GM), you wouldn’t particularly care if the company beats or misses earnings next quarter.  Your only real concern is that the company earns enough cash to cover its preferred dividend. 

Interest rate risk is also a far greater concern.  Remember, unless you buy at a deep discount to the call price (which is rare), the dividend is your only source of return.  A long period of rising rates could leave you with capital losses that you might never recover.  And frustratingly, the flip side of this relationship isn’t always true.  Depending on the preferred issue, you don’t necessarily get to benefit from prolonged falling rates.  In the case of callable preferreds, the company has the right to buy the stock back at the call price.  It hardly seems fair, but investors suffer the pain of rising rates without enjoying the benefits of falling rates.

And finally, you have to consider why a company would issue preferred stock at all.  Preferred stock dividends are not “expenses” in an accounting sense.  So why wouldn’t a company just issue bonds and benefit from the tax write-off that comes with interest expense?

The uncomfortable answer is that they are often already loaded with debt.  This is particularly true of the financial sector, where banks use preferred stock as a way to appease regulators who require a certain percentage of “Tier 1” capital.

So, preferred stocks are not for everyone.  They can even be a little tricky to buy for the uninitiated, as many do not have standard ticker symbols. You have to look them up by cusip number instead, which may require the assistance of a broker depending on which brokerage house you use.

Even with all of these caveats, many investors are attracted to preferred shares for the high current income.  And if you are going to buy preferreds, an ETF is not a bad way to do so.  Through a preferreds ETF, you get instant diversification.  The table below summarizes some of the popular ETF options:

Exchange Traded Fund



iShares US Preferred Stock Index



PowerShares Preferred Portfolio



Market Vectors Preferred Securities ex Financials



Global X SuperIncome Preferred ETF



 Of the four securities listed, only the iShares US Preferred Stock ETF ($PFF) and the PowerShares Preferred Portfolio ($PGX) have much in the way of trading history.  The MarketVectors Preferred Securities Ex-Financials ($PFXF) and Global X SuperIncome Preferred ($SPFF) both began trading only this month, showing how popular this sector has become of late. 

With this exception of PFXF, all of the other ETFs have a very high weighting in the financial sector.  For better diversification, it might be advisable to purchase PFXF in addition to your choice of one of the remaining three.  Though it yields slightly less than the others, my choice of the financial-heavy preferred ETFs would be PFF due to its greater liquidity and longer trading history. 

 Disclosures: Sizemore Capital does not currently have a position in any security mentioned.

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Sizemore Capital Allocation Change: Dividend Appreciation

Sizemore Capital is making a strategic allocation shift for all ETF portfolios with U.S. large cap exposure.  This affects the Tactical ETF Portfolio and the Strategic Growth Allocation. To be consistent with Sizemore Capital’s focus on dividend growth, we are eliminating our long-term positions in the iShares S&P 500 Index (NYSE:$IVV) and replacing them with […]

Sizemore Capital is making a strategic allocation shift for all ETF portfolios with U.S. large cap exposure.  This affects the Tactical ETF Portfolio and the Strategic Growth Allocation.

To be consistent with Sizemore Capital’s focus on dividend growth, we are eliminating our long-term positions in the iShares S&P 500 Index (NYSE:$IVV) and replacing them with the Vanguard Dividend Appreciation ETF (NYSE:$VIG). 

The Vanguard Dividend Appreciation ETF tracks the performance of the Dividend Achievers Select Index, which consists of U.S. stocks that have long history of raising their dividends.  Every stock in the portfolio must have raised its dividend for a minimum of 10 consecutive years.

Much of our research and investment in recent years has focused on income and income growth, and for good reason.  Capital gains can be ephemeral, and the only way that investors can realize their returns is by selling shares.  Rather than enjoying the milk in the form of dividends, you end up slaughtering the cow. And continuing this analogy, once the cow is gone investors are left with nothing to eat.

I should note that both the Tactical ETF Portfolio and Strategic Growth Allocation are long-term growth models with current income as only a secondary objective. But even for growth-oriented investors with years or decades until retirement, a dividend-growth strategy makes sense, and the Vanguard Dividend Appreciation ETF is very consistent with a growth strategy.

Remember, the Vanguard Dividend Appreciation ETF does not have current income as its primary objective.   With a current dividend yield of 2.0%, it doesn’t pay significantly more than the S&P 500’s 1.9%.

Its focus on dividends is instead a focus on quality.  When a company raises its dividend, it sends a powerful message that management sees better days ahead. The discipline required to consistently pay a dividend also has a way of discouraging management from wasting shareholder money on quixotic empire building or on overpriced mergers that fail to deliver value.  It forces management to be efficient.  And importantly, it also helps to keep management honest.  Paper earnings can be manipulated, but dividends have to be paid in cold, hard cash.  Dividends don’t lie.

My good friend Albert Meyer of Bastiat Capital refers to his own strategy as “an index fund, but without all the rubbish.”  (It sounds classic in his professorial South African accent.)

This is how I like to think of the Vanguard Dividend Appreciation ETF.  With a portfolio turnover of only 14% per year and a management fee of only 0.13%, VIG enjoys the best aspects of an index fund—tax and fee efficiency—but without the baggage of the lower-quality companies that bog down most indices.

The Strategic Growth Allocation currently already has a position in the iShares Dow Jones Select Dividend ETF (NYSE:$DVY). It is fair to ask whether an additional position in the Vanguard Dividend Appreciation ETF is redundant.  But to this question, I would give an emphatic “no.”

DVY is primarily an income-focused ETF with a heavy allocation the utilities sector.  VIG is a growth-focused ETF with greater exposure to the consumer and industrial sectors.  Though they both have “dividend” in their titles, their strategies are vastly different (see “Dividend ETFs for Growth and Income”).

Disclosures: IVV, VIG and DVY are positions in Sizemore Capital accounts.

5 Boring Stocks, 5 Sexy Yields

Investing is not all that different from choosing a spouse.  At some point in every man’s life, he has to make a choice.  Does he go for the alluring but volatile young vixen who will ultimately put him in an early grave, or does he take the more rational course of action and choose a […]

Investing is not all that different from choosing a spouse.  At some point in every man’s life, he has to make a choice.  Does he go for the alluring but volatile young vixen who will ultimately put him in an early grave, or does he take the more rational course of action and choose a mature, dependable companion to spend his life with?  (Women face similar choices themselves; to marry the handsome but unpredictable young buck or the more stable—if somewhat boring—workhorse?).

It’s nice if you can have it all, of course; romance and stability in a partner.

For investors, much the same can be said about stocks.   Sexy “glamour” stocks—and the heartburn they often bring—are best left to shorter-term traders.  Bonds offer stability but nothing in the way of excitement.   If you are looking for something in the middle—predictable, long-term wealth building—dividend-paying stocks are likely your best option.  They allow you reach your financial goals while still managing to sleep at night.

Today, I’m going to recommend five boring stocks with sexy yields.  We’ll start with that most mundane of American retailers Wal-Mart (NYSE: $WMT).

Wal-Mart is about as dull as it gets as a company; the world’s largest retailer of the basic “stuff” of modern life—everything from food to build-it-yourself furniture.

But Wal-Mart also  happens to be a dividend-growing dynamo.  In 2002, just 10 years ago, Wal-Mart paid $0.075 per quarter in dividends.  Today, it pays $0.398—an increase of more than five times.

With Wal-Mart’s domestic expansion slowing in the years ahead (and thus needing less cash for investment), I expect the company to continue aggressively raising its dividend.  The stock currently yields an attractive 2.7%, which is substantially more than what most bonds pay.

Next on the list is consumer products giant Kimberly-Clark (NYSE:$KMB).  If you thought it was impossible for a company to be more boring than Wal-Mart, then you failed to consider Kimberly-Clark.  The company manufactures and sells diapers, Kleenex, and other basic products you might find in your bathroom.

But like Wal-Mart, Kimberly-Clark is a dividend-raising dynamo.  Over the past decade, its quarterly dividend has risen from $0.30 to $0.74; not too shabby when you consider what a volatile decade it has been.  Kimberly-Clark currently yields 3.7%.

I can’t mention Kimberly-Clark without mentioning its much larger rival Procter & Gamble (NYSE: $PG).  Chances are good that half or more of the products in your bathroom and laundry room were made by Procter & Gamble, at least if you are an American (overseas, rival Unilever (NYSE:$UL) tends to dominate).  They make Crest toothpaste, Gillette razors, Charmin toilet paper, and Pampers diapers, among many, many other brands.  This is a company that Warren Buffett has dabbled in for years, and it’s easy to understand why.  Demand for its products is stable, and its brands have incredible intangible value.

Over the past decade, P&G has raised its quarterly dividend from $0.19 to $0.562; again, not a bad run.  The stock currently yields 3.5%.

Moving on, let’s take a look at the oh-so-boring world of natural gas transportation.   On this front, I recommend Williams Companies (NYSE: WMB).

Stop for a minute and think.  Can you think of anything more boring than natural gas transportation?  Yeah, me neither.

But William’s dullness is its strength.  Natural gas pipelines are stable, predictable businesses, regardless of what happens to the price of gas.  And if anything, the current glut in natural gas supplies should bode well for pipeline companies like Williams.  Cheaper prices encourage higher consumption.

Williams Companies is an IRA-friendly way to get access to the master limited partnership Williams Partners (NYSE:$WPZ).  For tax reasons that go beyond the scope of this article, master limited partnerships cannot be held in IRA accounts.  But as a corporation with a large ownership interest in a partnership, WMB can.

Williams Companies  currently yields 3.1%, and I expect this to rise substantially over time.

Finally, I want to put out one recommendation that is likely to get your pulse racing a little more than the rest: Spanish telecom juggernaut Telefonica (NYSE: $TEF).

There is little more boring than a telecom utility.  While you may “ooh and ah” over your latest iPhone, you generally spend very little time thinking about the company that provides cellular service to it.

Telefonica would have to be considered “riskier” than the rest of these recommendations by virtue of being domiciled in Spain.  But with a yield of over 11% at current prices, I consider it a risk worth taking.

Telefonica gets nearly half of its revenues from the fast-growing markets of Latin America, so continued recessionary conditions in Spain do not present an undue risk to Telefonica’s business.  Disruptions to the European financial system could result in the company cutting its dividend to preserve cash, but I consider this unlikely and, again, a risk worth taking for the potential rewards.

Disclosures: All securities mentioned are holdings of the Sizemore Capital Dividend Growth Portfolio.