Thoughts on Peferred Stock ETF (PFF or PGX) in rising interest rate environment

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dundee
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Thoughts on Peferred Stock ETF (PFF or PGX) in rising interest rate environment

Post by dundee » Fri Oct 26, 2018 1:53 pm

Dear bogleheads,

I have some money sitting in the bank, not making much interest. The yield on Preferred stock ETF's such as PFF or PGX is currently at 5.6%. So, it is an attractive idea to put some money into it.

Given the rising interest rate environment, is this a good idea? if the rates go up, would the yield go down? Would the principal loose value? For reference, these ETF's have moved within a narrow band of +/- 5% in the last 5 years. Currently it is on a downward trend.

jbranx
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Re: Thoughts on Peferred Stock ETF (PFF or PGX) in rising interest rate invironment

Post by jbranx » Fri Oct 26, 2018 2:36 pm

Lowering the corporate tax rate has made preferreds less appealing to corporate buyers. While preferreds are higher in the corporate structure over common, they have characteristics that make them difficult to analyze. Most are callable within about five years at either $25 or $1000--depending on the issue. If rates are good for the investor, they get called; good for the corporation, they remain in effect. Jason Zweig did a WSJ piece last year about most prefs. being at premiums. I now see some selling at small discounts to $25 but the best time to buy is when they fall into the lower twenties.

If you want to avoid the calls, check out WFCPRL and BACPRL. Both of these are yielding close to 6%, at a premium, however, neither can be called until both of the banks sell at dramatically higher stock prices since they are conversion issues sold during the worst of the financial crisis. www.quantumonline.com is the best source for terms; search first for WFC and BAC and then look at the issues. BAC has series K now at a slight discount and callable in 5 years. PFF and the other ETFs have good liquidity which individual issues frequently don't. Best to put some of the top holdings tickers in a quote box and see if they are at premiums or discounts.

If any of this is confusing...well, best to stick with straight bonds or common stocks. Yields are usually high for good reasons.

jalbert
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Re: Thoughts on Peferred Stock ETF (PFF or PGX) in rising interest rate environment

Post by jalbert » Fri Oct 26, 2018 2:38 pm

Preferred stock is fairly sensitive to interest rates on the long end of the yield curve because it is basically an infinite duration maturity bond without a contractual guarantee to make an interest payment, other than no dividends can be paid to common shareholders if payments to preferred shareholders have not been made. Rising interest rates are not a preferred stock investor’s friend.
Last edited by jalbert on Sun Oct 28, 2018 3:47 am, edited 2 times in total.
Risk is not a guarantor of return.

jbranx
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Re: Thoughts on Peferred Stock ETF (PFF or PGX) in rising interest rate environment

Post by jbranx » Fri Oct 26, 2018 3:27 pm

Another consideration to keep in mind is that preferreds are concentrated in the banking, reit, and utility sectors. None, with the exception of a few closed-end preferreds that are required by the '40 Act to have 2X coverage, have anywhere close to AAA ratings, though all in those two etf's are investment grade. Ignore the duration estimate that the ets's show at around six years; that estimate will not be accurate if interest rates rise and corporations decide not to call the issues on the stated date. Unlimited duration is possible, interest rate sensitivity, liquidity risk, and sector concentration all add up to good explanations for why the yields are higher than on corporate bonds. Check the price performance of those two etf's during the crisis: I think they dropped like a rock.

Valuethinker
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Re: Thoughts on Peferred Stock ETF (PFF or PGX) in rising interest rate environment

Post by Valuethinker » Fri Oct 26, 2018 4:23 pm

dundee wrote:
Fri Oct 26, 2018 1:53 pm
Dear bogleheads,

I have some money sitting in the bank, not making much interest. The yield on Preferred stock ETF's such as PFF or PGX is currently at 5.6%. So, it is an attractive idea to put some money into it.

Given the rising interest rate environment, is this a good idea? if the rates go up, would the yield go down? Would the principal loose value? For reference, these ETF's have moved within a narrow band of +/- 5% in the last 5 years. Currently it is on a downward trend.
If there is another financial crisis holders will get slaughtered.

If interest rates fall they will get called. If they rise you will get extended may be forever.

Read Larry Swedroe. This is a heads they won tails you lose investment.

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grabiner
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Re: Thoughts on Peferred Stock ETF (PFF or PGX) in rising interest rate environment

Post by grabiner » Fri Oct 26, 2018 10:07 pm

In addition to the risk of non-payment (which is correlated with the stock-market risk of the rest of your portfolio), you have the interest-rate risk of an infinite-maturity bond, which means that the duration is the reciprocal of the interest rate, which is 18 years at your 5.6% yield. Is the higher yield on preferred, relative to, say, intermediate-term corporate bonds (4.25% yield on Vanguard Intermediate-Term Corporate Bond ETF with a 6-year duration), worth taking those risks?
Wiki David Grabiner

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