PFFD - PFFD: I Added More This Week

Summary

• I own PFFD alongside shares of PFXF to give my portfolio extra diversification.
• The current yield of 5.76% is attractive.
• For investors "waiting out the bear market," I find short-term Treasury yields of 3.5% to be more attractive.

Introduction

This past week, during the recent summer sell-off, I purchased more shares of the Global X U.S. Preferred ETF ( PFFD ).

The shares had fallen about 6-7% from the recent summer high and I thought there was a decent entry point.

The dividend yield of 5.76% alongside ample liquidity made the recent sell-off an opportunity to add shares to my long-term holdings.

Macro Analysis

Last week at the Jackson Hole meeting, Chairman Powell indicated that interest rates would be "higher for longer." Almost immediately, rate hike expectations were adjusted upward. Short-term yields popped and the PFFD quickly sold off. I do not expect the rising rate environment to persist more than 6-9 months. Thus, I am comfortable holding PFFD for the long haul. If you expect that we have embarked on an even longer rate hiking cycle, you are better off buying short-term treasury bonds.

Interest Rates

I should note that I find short-term Treasury bonds to be more attractive than preferred shares at this time. I allocated most cash to short-term treasury bonds with a duration of one to two years. The most comparable ETF would be the iShares Short Treasury Bond ETF (SHV). The yield to maturity on the bonds that I purchased was between 2.7% and 3.5%. As you can see, the premium of 2% to hold the PFFD is not particularly enticing. I believe that this is the main reason why investors have recently shunned the PFFD and opted for short-term treasury holdings.

Expense Ratio

The PFFD expense ratio of 0.23% is reasonable given the diversity of the holdings and the liquidity of the shares. If you try to build out a portfolio of comparable individual preferred shares, you spend a lot of time waiting to get filled as the bid ask spread is enormous with many preferred shares. Thus, you would really not save much money by creating your own personal ETF of preferred shares.

Liquidity

One of the worst features of preferred shares is the lack of liquidity. In a market swoon where the VIX rises to over 40, I find the liquidity evaporates from many individual preferred shares. During the pandemic swoon in March of 2020, I watched many preferred shares go no bid for days at a time.

Fortunately, PFFD appears to have an institutional following and liquidity is ample for individual investors. The average volume over the last two months has been almost 1.2 million shares.

Diversification

I find the diversity of holdings of PFFD to be adequate given the fact that this ETF is heavily skewed towards financial companies. For this reason, I own the PFFD and PFXF ( written about recently ) in equal quantities. The PFXF does not hold any financial companies and is heavily weighted towards Utility companies. By using both ETFs, I find that I get enough diversification for this part of my portfolio.

Over the last month, PFFD has become slightly more skewed towards financial companies. At 68% Financials, PFFD is basically limited to one industry.

Credit Quality

One of the reasons why I have purchased more short-term Treasury bonds as opposed to PFFD is that the credit quality of the companies in the PFFD is triple B rated. I do not want to take on more credit risk to make 2-3% extra yield per year. For that reason, my preference is short term treasury bonds. That is my vehicle of choice to ride out the bear market. However, a small portion of long-term cash was allocated to PFFD as it is difficult if not impossible to determine when the bear market has actually bottomed.

Conclusion

The recent sell-off of 6-7% has provided another opportunity for long-term investors to accumulate PFFD. It is a similar opportunity to the opportunity in mid-June when I last wrote about the PFFD .

However, I want to emphasize that I find the opportunity set in short-term Treasury bonds to be even more attractive as my main objective is parking some cash while waiting out the bear market. The difference between 3.45% and the 5.76% that I can make in the PFFD is not really worth it over the short term. If the bear market is more prolonged and the market chops around for a few years, PFFD will be a better choice.

PFFD features a yield of 5.76% and an expense ratio of 0.23%. Since I match PFFD with my holdings of PFXF, I am able to build a portfolio of preferred shares with adequate diversification. With the PFXF alongside my holdings of PFFD, I am able to avoid the pitfalls of owning an ETF that has 68% of holdings in one industry.

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