Preferred Portfolio for "Juicy Yields"

10/18/2016 9:00 am EST

Focus: ETFs

Juicy 5% to 7% yields are available from preferred stocks, the equity and fixed-income hybrids issued by corporations, mainly banks suggests Tim Begany, editor of Personal Finance.

Preferred stocks also put up impressive total returns, and they’re less risky than traditional common stock.

Yet many investors overlook preferreds, as they’re a tiny portion of the securities markets and most people aren’t comfortable trading them.

We recommend fund investors play these high-yielders through the PowerShares Preferred Portfolio (PGX), a $4.7 billion exchange-traded fund launched in 2008.

PGX yields 5.8% and posted annualized total returns of 10.1% and 8.3%, respectively, the trailing three- and five-year periods.

That’s excellent for an investment that, given its relative stability, behaves more like a bond than a stock. Many pure stock funds don’t do that well. And PGX’s three- and five-year performance beats 99% and 66% of peers, respectively.

PGX owns a representative sample (about 240 now) of the BofA Merrill Lynch Core Plus Fixed Rate Preferred Securities Index, with the same risk and performance characteristics as the index.

To be in the BofA Merrill Lynch index, a preferred stock must have at least a B3 credit rating based on an average of the three major ratings agencies. This rule eliminates preferreds with high default risk.

Banks are by far the leading preferred stock issuers; PGX is 85% in financial companies. However, there’s also substantial issuance by utilities (7% of fund assets), telecoms (4.5%) and industrial companies (2.6%).

PGX charges a reasonable 0.5% expense ratio, in line with the 0.51% peer group average. The fund is 68% less volatile than the S&P 500, despite having an equity component.

PGX only buys or sells as needed to track its index, so the portfolio doesn’t change much from year to year. Just 12% was replaced in 2015. Because turnover is so low the fund is highly tax-efficient, with no history of distributing taxable capital gains.

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By Tim Begany, Editor of Personal Finance

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