State Street gave birth to a new preferred stock Exchange Traded Fund (ETF) last Thursday and several readers and subscribers have asked what I think about preferred stock ETFs in general, and the new State Street ETF in particular (PSK). I will have more to say about investing in preferred stock ETFs versus individual issues in the upcoming October issue of the CDx3 Newsletter (what's this?), but wanted to give you this short version now.
An ETF is a fund composed of multiple securities, just like a mutual fund, except an ETF prices in real-time throughout the day just like other stocks (mutual funds only price once per day after the trading session so investors really never know the real market price of a mutual fund, they just know what the market price use to be). The new State Street ETF is one of only four preferred stock ETFs available. The other three are composed of approximately 80% bank-issued preferred stocks with about a third of the issues rated below investment grade. So these ETFs offer less diversification and more risk to preferred stock investors when compared to building your own preferred stock portfolio with a more diverse group of investment grade issues ("CDx3 Preferred Stocks"). State Street's offering has the stated goal of minimizing, but not avoiding, speculative grade preferreds. A welcomed improvement over the other choices. There have been several articles in the financial press over the last few days about the new State Street preferred ETF, several of which have done their readers a disservice by implying that preferred stock ETFs can be part of a capital gain investment strategy. They point to the impressive gains that have been made so far this year. You can read one such article from MarketWatch (an online Wall Street Journal publication) and my comments to it by clicking here (see comment #4 at the bottom of the article). As I described in my comments to the MarketWatch article, preferred stock ETFs eliminate what my book, Preferred Stock Investing, refers to as the Rule of Buyer/Seller Behavior (Preferred Stock Investing, page 43). This rule of preferred stock market price behavior is key to buying when the market price will tend to favor buyers and selling downstream when the market price will tend to favor sellers. The elimination of the Rule of Buyer/Seller Behavior by preferred stock ETFs also eliminates the capital gain component of preferred stock investing. Consequently, in additional to lower diversification and speculative grade exposure, preferred stock investors who favor adding a downstream capital gain to the great dividend income that preferreds tend to provide will probably be very disappointed with the long-term market price behavior of a preferred stock ETF. Preferred stock ETFs are intended for investors who are willing to take some risk in exchange for long-term, fixed dividend income more so than for those looking to increase their portfolio diversifcation with the highest quality preferred stocks plus have an opportunity for a downstream capital gain. Gains seen this year in preferred stock ETFs have been caused by a recovery from the Global Credit Crisis, not because these ETFs adhere to the Three Rules of Market Price Predictability (Preferred Stock Investing, chapter 3). Look for my more detailed analysis regarding investing in preferred stock ETFs in the upcoming October issue of the CDx3 Newsletter. Many Happy Returns.
