2023-12-26 13:44:45 ET
Summary
- PFXF offers a diverse fund of preferred shares across many industries.
- Over the last decade, its dividend has been stagnant or declined, and total returns are negative.
- The preferred equity in its holdings will continue to create disappointment for long-term holders.
VanEck Preferred Securities ex Financials ETF ( PFXF ) is a fund designed to give investors a diverse pool of preferred stock in various companies and sectors. Preferred shares typically have appeal as a higher-yielding income source than bonds or common stocks, while also enjoying the tax treatment of dividends instead of interest. Currently yielding over 7%, many folks may consider if PFXF is a good income investment.
I will make the case that it is not, given its history, the nature of preferred shares, and how that nature shows itself in a preferred fund like this, making PFXF a sell .
Concept of the Fund
According to the Prospectus , the investment objective of the fund is:
VanEck® Preferred Securities ex Financials ETF (the "Fund") seeks to replicate as closely as possible, before fees and expenses, the price and yield performance of the ICE Exchange-Listed Fixed & Adjustable Rate Non-Financial Preferred Securities Index (the "Preferred Securities Index" or the "Index").
ICE describes the Index itself, here :
...Index tracks the performance of exchange-listed U.S. dollar denominated hybrid debt, preferred stock and convertible preferred stock publicly issued by non-financial corporations in the U.S. domestic market. Qualifying securities must be: publicly issued; have at least one day remaining to maturity; at least 18 months to final maturity at time of issuance; and have $250 million face amount outstanding. The index includes both fixed and floating rate coupons and dividends. Securities associated with Financial sector issuers based on the ICE sector classification schema are excluded, as are 144a securities without registration rights, RegS securities, securities with sinking funds and securities in legal default.
Thus, we can see that it's US-focused and also that it's not purely invested in preferred shares but also includes some debt instruments. There are other requirements that you can read, but that gives you the main idea: it's meant to be an income fund that primarily invests in preferred shares. Additionally, the fund is not invested in securities from the financial sector. The Index, also known as PFAN, is compared with PFXF's performance since inception here:
As such, we can see the fund very closely follows PFAN's performance, meaning it's successfully tracking the Index.
Composition
What kind of investments are in this fund? First, let's look at the top ten holdings:
This shows us that it holds securities in a lot of large-cap stocks. AT&T securities currently make up more than 10% of the fund. That said, these top ten don't give the whole story.
This table shows us that 11% are in REIT securities, some of which are smaller capitalization.
The largest composition is in utilities. Between these two sectors, the fund has many sectors that are likely to have consistent cash flows as the basis for the income of the securities. The remainder of the funds is split variously among consumer goods, basic materials, health care, tech, industrials, and financial services. Overall, this is a very diverse net.
Historical Returns
We showed how the fund compares to the return of PFAN. It's almost identical, as intended. With that said, how does PFXF perform compared to the S&P 500?
This shows us that it does not beat the market in terms of total returns. PFXF's total returns are actually negative for the last decade!
It's not hard to understand why. Preferred equity does not grow in intrinsic value like common equity, as only the common benefits from the long-term growth of this business, unless the preferred has some kind of convertible feature. Otherwise, a preferred stock's cash flow is its dividend, which is usually fixed. If you make a fund based on this, this is how it will look over the long term.
Additionally, we can see that, as interest rates shot up over the last two years, many preferred shares went down in market value to have more competitive yields. Common does not necessarily experience this because it can still grow in spite of higher interest rates (depending on the business).
Yet, being a preferred share ETF, we might ask what the divided history has been. Perhaps it's been a good result for income investors.
Here, we see that mostly declined over the last decade. The payout has been as high as $1.23 per share and as low as $1.02. For the TTM, the total payout so far has been $1.26.
Across that same period, during its highs and lows, we can also see that its monthly payments have been very uneven, which would likely be a nuisance for your average income investor that needs steadier cash flows.
The higher dividend for the TTM is likely due to any floating-rate instruments in the portfolio, causing distributions to increase. As such, only while interest rates are at these elevated levels will the payout be like this. Similarly, some preferred may have accumulated dividends that were not paid in a year like 2020 but eventually were more recently as those companies improved.
A Look to the Future
While past performances are no guarantee of future results, we nevertheless have good empirical data about what such a fund can do. Being primarily preferred equity, I believe that the fund will continue to produce an annual dividend per share of at least $1.00 and maybe as high as $1.30, fluctuating based on things like interest rates and business cycles that help or depress the earnings of its holdings. I think there's nothing intrinsic to this fund to push its payout up more than that.
It will probably be better than a bond fund, in that it has managed to pay its income without much loss of principal over time. Of course, given its poor total returns and the lack of income growth to keep up with inflation, I don't see any trends that would reverse this. Preferred equity just cannot ride long-term growth trends that common can.
One potential upside is that interest rates decrease, the most of the shares in the fund should trade closer to par, raising the NAV of the fund.
This chart shows that the reverse already happened. As rates went up, NAV went down to increase the yield. How quickly this will occur is another story. The recent rate hikes were some of the fastest in history in a desperate bid to stave off inflation. We shouldn't necessarily assume that rates will decline as quickly as they increase.
A 7% yield just isn't an attractive valuation, given all of this. For something like this, a double-digit yield should be required by the market, putting a fair value somewhere between $10 and $13. Otherwise, there are better income funds in terms of yield and growth, like Global X S&P 500® Covered Call ETF ( XYLD ) and JPMorgan Equity Premium Income ETF ( JEPI ), both of which use covered call strategies and have positions in common equity.
Conclusion
VanEck Preferred Securities ex Financials ETF, as a preferred equity fund, is an interesting idea. That said, its long-term results are disappointing, even if we focus purely on the income. There are other funds whose structures allow them to grow their income over time and at least keep up with inflation and whose yields are comparable to that of PFXF (if not higher). Even if the dividend stays on the high side, its uneven monthly payments may prove cumbersome for folks who need a monthly income.
If you're going to invest in preferred equity, I think it ought to be an individual issue that you have vetted and whose features and price offer a return that the rest of the market is just missing. Otherwise, people who prefer funds will probably be better served investing in those primarily composed of common equity. This is why I think the fund is a sell .
For further details see:
PFXF: The Problem With Preferred Shares