2023-10-09 10:04:55 ET
Summary
- VanEck Preferred Securities ex Financials ETF offers diversified exposure to preferred securities outside of the financial sector.
- Preferred securities provide higher dividends, reduced risk, and potential for fixed income.
- The fund is heavily weighted in REITs, which may explain its underperformance compared to other preferred stock ETFs.
One pillar to wealth is having residual income. - Nipsey Hussle.
Preferreds aren't a part of the marketplace that are often talked about but can be interesting vehicles in an overall portfolio. Most preferreds tend to be Financials-heavy, but with lingering concerns around the health of the banking system, there are products that still provide access without sector-specific exposure.
The VanEck Preferred Securities ex Financials ETF ( PFXF ) is one such fund. While this does on the surface look appealing, the results have been a bit surprising.
Understanding Preferred Securities
Before we delve into the specifics of PFXF, it's important to understand the nature of preferred securities. Preferred securities, often referred to as preferreds, are a type of hybrid financial instrument that combines attributes of both debt and equity securities. They represent ownership in a corporation, much like common stocks, but without the associated voting rights.
Preferred stockholders typically enjoy a higher claim on a company's earnings and assets compared to common stockholders. They receive dividend payments before common stockholders and, in the event of a company's liquidation, are prioritized over common shareholders when disbursing the company's assets. If I'm right about a corporate credit event broadly on the way, you'd prefer having preferreds than debt because of this higher claim on assets.
Preferred securities offer several advantages to investors:
- Higher Dividend Payments : Preferred securities usually provide higher dividends than common stocks. These dividends are generally paid out before any dividends to common shareholders.
- Reduced Risk : Preferred securities are generally less volatile than common stocks, as preferred shareholders have a higher claim on a company's assets and earnings.
- Potential for Fixed Income : Preferred shares often offer fixed dividends, providing a steady income stream. This is particularly beneficial for income-focused investors, such as retirees.
- Convertible Features : Some preferred securities can be converted into common shares, offering the potential for capital appreciation if the company's common stock price increases.
An Overview of PFXF
Now that we've gotten the education part of preferreds out of the way, let's tackle PFXF. The ETF tracks an index that excludes securities issued by financial companies, which have historically dominated broad-based preferred indices. This exclusion allows for greater sector diversification and lower concentration risk without sacrificing yield potential.
Following the 2008 financial crisis, banks began issuing substantial amounts of preferred stock to meet the heightened capital requirements set by regulators. This led to an overconcentration of the sector, which currently comprises over 75% of the listed U.S. preferreds market. PFXF targets preferred securities issued by companies outside the financial sector, offering differentiated exposure without sacrificing yield potential.
Instead, the bulk of the ETF is made up of three sectors - real estate investment trusts ("REITs"), Utilities, and Telecom. These all tend to be income-focused investment sectors when it comes to common stock so no major surprises here.
Real Estate Exposure in PFXF
The question really becomes the focus on REITs in the fund. I'm actually broadly bullish on REITs from a multi-year perspective as I suspect far more bad news has been discounted in the sector more than other parts of the broader marketplace. Still, this could explain why despite the lack of Financials in the fund, the ETF has actually underperformed the iShares U.S. Preferred Stock ETF ( PFF ) which is heavy in Financials. If anything, it looks like PFF may meaningfully continue to outperform on a relative basis as the ratio turns lower.
Conclusion
Investing in preferred securities, specifically through the VanEck Preferred Securities ex Financials ETF, can offer attractive benefits for income-focused investors. It allows for diversification, reduces volatility associated with common stocks, and provides a steady stream of income through dividends. I think it's a good fund, but it's clear that movement here oddly enough seems to favor preferreds with Financials. This may be because REIT preferreds (alongside Utilities, which on the common side have badly performed this year) could have severe problems dealing with higher rates. Still, it's worth keeping this fund on your radar. VanEck Preferred Securities ex Financials ETF is a pass for me now.
For further details see:
PFXF: REITs And Utilities Hurt More Than Excluding Financials (For Now)