Three Preferred Stock ETFs Paying Retirees Steady Income Without the Stock Market Whiplash

Quick Read

• Three preferred stock ETFs deliver monthly income yields from 5% to nearly 8.1%, giving retirees steady income without requiring expertise in complex preferred securities.

• Warren Buffett’s $5 billion Bank of America preferred stock deal netted him roughly $14 billion in profit, showcasing the asset class’s unique flexibility and upside.

• All three ETFs posted weak 5-year returns as Fed rate hikes from 2% to 4% punished preferred stocks the same way they punish bonds.

Michael Douglas’ Oscar winning performance as Gordon Gekko in Wall Street (1988) had many of the best lines. One of the more memorable and funny ones was:

“Their analysts don’t know preferred stock from livestock.”

The ironic thing is – there’s a kernel of truth in that remark, and it is a reason why preferred stocks remain primarily in the hands of institutions, trusts, and sophisticated investors. Preferred stocks can often be an analyst’s headache, since there is no set format. Each preferred stock comes with its own set of rights, conversion, coupon, redemption, and a long list of other parameters- even preferred stocks of different series from the same issuer. 

Individual investors who are interested in obtaining exposure to preferred yield income with the potential corresponding upside but don’t have the expertise or research time to fully study the sector might instead wish to consider these ETFs:

• Virtus InfraCap U.S. Preferred Stock ETF (NYSE: PFFA) – 8.05% yield

• Global X U.S. Preferred ETF (NYSE: PFFD) – 6.33% yield

• iShares Preferred and Income Securities ETF (NASDAQ: PFF) – 5.54% yield

Why Warren Buffett Likes Preferred Stock

Warren Buffett’s request for customized preferred stock to bail out Bank of America for $5 billion created a $14 billion profit for him in under 10 years.

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In the aftermath of the subprime mortgage meltdown of 2008, Bank of America was floundering and in danger of falling down the same drain as Washington Mutual and numerous other firms. Warren Buffett came to BoA’s rescue, but demanded specific terms that BoA accommodated  with a customized preferred stock specifically catered to meet those demands. The subsequent $5 billion Bank of America Cumulative Perpetual Preferred Stock Series T issue included:

• 6.0% interest ($300 million annual yield income)

• Bank of America buyback option with 5% Premium (worth $250 million) 

• The Preferred Shares contained 10-year warrants to buy 700 million Bank of America common stock shares at $7.14 at any time between 2011 and 2021. 

Buffett has since exercised his warrants to become one of Bank of America’s largest shareholders. Due to their flexible parameters, preferred stocks also may contain such qualities as:

• Superior voting rights (1 preferred stock=100 votes vs. 1 common share=1 vote)

• Call protections

• Board Representation

• Convertibility options

• Fixed dividends with qualified tax treatment at lower capital gains level instead of as income (in most, but not all cases)

• Ranked junior to bonds but senior to equity in the event of defaults

• Shared interest rate sensitivity with bonds

Buffett is believed to have made a roughly $14 billion profit on the deal in the aggregate. 

Virtus InfraCap U.S. Preferred Stock ETF

PFFA’s higher expense ratio is due to active management utilizing leverage to boost returns and income.

Actively managed, PFFA was launched on 5/15/2018, PFFA is geared towards income-focused investors. The fund uses 20-30% leverage to bump income and gains, but can also lose proportionately in down markets. Preferred stocks comprising its 193 holdings are selected at manager’s discretion. Payouts are monthly.

Top 5 Holdings:

Global X U.S. Preferred ETF

Unlike PFFA, PFFD is passively managed and follows the ICE BofA Diversified Core U.S. Preferred Securities Index.

Passively managed, PFFD tracks the ICE BofA Diversified Core U.S. Preferred Securities Index. It debuted on 9/11/2017. PFFD pays out monthly. It holds 228 different preferred stocks.

Top 5 Holdings:

iShares Preferred and Income Securities ETF

PFF’s $13 billion AUM warchest is larger than PFFA and PFFD combined.

PFF is also passive and tracks the ICE Exchange-Listed Preferred & Hybrid Securities Index. The fund’s inception date is 3/26/2007, making it the oldest of the 3. It has 457 different holdings. It’s also the largest, with $13.8 billion AUM. Dividends are paid monthly. 

Top 5 Holdings:

Like bonds, preferred stocks are sensitive to interest rates. The low 5-year return rates of all three ETFs coincide with the Fed rate hikes from 2.25% to 4.25% in response to inflation from  Bidenomics. Prudent investors with tax concerns may appreciate the qualified dividends tax level of preferreds. All other things being considered equal, holding preferred ETFs is not dissimilar to holding bond ETFs.

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