Investors in preferred stocks and in corporate bonds have similar motivations. They’re looking for a long-term investment with a reasonable and regular return on their money.
Today’s investors can choose exchange-traded funds (ETFs) that focus on preferred stocks or corporate bonds. Whether you choose one or the other should be based on the current economic environment as well as your investment strategy.
- If you’re looking for high yield, consider a preferred stock ETF. This is especially true in times when interest rates are low. Preferred stock ETFs are considered higher quality than common stock ETFs because of their relative lack of risk. You will have priority over common shareholders for dividends and any claims on assets. However, preferred stock ETFs usually underperform equity ETFs during bull markets.
- Most bond ETFs offer a diversified portfolio of bonds, excellent liquidity, and low expenses. One of the bond ETFs covered below should clearly offer the most long-term potential regardless of how the broader stock market is performing.
- Preferred stock ETFs can perform particularly well in comparison with bonds when interest rates are low.
- Bond ETFs can offer competitive long-term returns regardless of the movements of the stock markets.
- Both can offer steady income to the investor with very low costs.
Preferred Stock ETFs
From the investor’s viewpoint, preferred stocks are a blend of a bond and a stock. Their prices aren’t volatile like common stock shares. The point is the dividends these shares pay. They also are considered safer than common stocks. Even in the event of bankruptcy, preferred shareholders are closer to the front of the line for repayment than common shareholders.
Preferred stock ETFs give the investor exposure to a range of preferred stocks, thus diversifying your portfolio.
Let’s start with a quick look at two of the most popular preferred stock ETFs.
Invesco Preferred ETF (PGX)
Tracks the ICE BofAML Core Plus Fixed Rate Preferred Securities Index. Financials as of Oct. 10, 2021.
- Total Assets: $7.41 billion
- 30-Day Average Volume: 2,704,585
- Expenses: 0.52%
- 12-month Distribution Rate: 4.77%
- Inception Date: Jan. 31, 2008
- 1-Year Performance: 7.75%
iShares US Preferred Stock (PFF) ETF
Tracks the S&P U.S. Preferred Stock Index. Financials as of Oct. 10, 2021.
- Total Assets: $19.89 billion
- 30-Day Average Volume: 5,699,237
- Expenses: 0.46%
- 12-month Trailing Yield: 4.45%
- Inception Date: March 26, 2007
- 1-Year Performance: 12.20%
The appreciation and high yield for the two preferred stock ETFs above might be tempting, but when interest rates increase they’re not likely to perform as well. Both also performed poorly during the financial crisis, demonstrating a lack of resiliency.
Preferred Stock ETFs Vs Bond ETFs
A bond is a loan to a corporation in return for a regular payment of interest. As with preferred stocks, the point of bonds, to the investor, is the regular income they generate.
All bonds are rated by one of several rating agencies for the creditworthiness of the companies that issue them. The highest-rated bonds may pay the least but are the safest. Low-rated bonds are riskier but pay better.
So-called “junk bonds” are at high risk of default by their issuers.
SPDR Bloomberg Barclays High Yield Bond ETF (JNK)
Tracks the Bloomberg Barclays High Yield Very Liquid Index. Financials as of Oct. 10, 2021.
- Total Assets: $9.78 billion
- Average Volume: 7,410,339
- Expenses: 0.40%
- 12-month Yield: 4.66%
- Inception Date: Nov. 28, 2007
- 1-Year Performance: 9.97%
iShares 20 Year Treasury Bond (TLT)
Tracks the Bloomberg Barclays Long U.S. Treasury Index. Financials as of Oct. 10, 2021.
- Total Assets: $14.78 billion
- 30-Day Average Volume: 18,823,713
- Expenses: 0.15%
- 12-month Trailing Yield: 1.52%
- Inception Date: July 22, 2002
- 1-Year Performance: -10.52%
Still, these two choices illustrate the many situations in which yield or lack of it can be deceiving. Most investors chase high yield, not realizing that they’re often putting themselves more at risk for depreciation. A high yield doesn’t mean anything if an ETF’s shares slide.
That’s the beauty of TLT. The yield might not be extraordinary (still relatively generous), and it tends to appreciate during difficult times because big money rushes to safety.
Note that JNK is not a symbol selected for a fund that invests in the highest-quality AAA-rated bonds.
The Bottom Line
Preferred stock ETFs are more appealing in low interest rate times thanks to their high yields, but they’re not likely to appreciate as much as ETFs tracking common shares during bull markets.
Bond ETFs have a reputation for offering greater safety, but it depends on the bond ETF. For instance, JNK offers a high yield, but it’s not a place be during poor economic periods when defaults are more likely. TLT might not offer as much yield, but it offers resiliency and the low expense ratio is a bonus.