Building Your Own Preferred Stock Portfolio - How Much Better Is It?

As investors we make judgments about our investment choices continually. Preferred stock investors generally favor lower-risk alternatives since they invest primarily for the reliable periodic dividend income that preferreds can provide.

But many preferred stock investors are left wondering whether they are better off by (A) building their own portfolio of specific preferred stock issues or (B) investing in a preferred stock fund (such as the iShares Exchange Traded Fund PFF).

PFF is composed primarily of preferred stocks issued by banks (90%) or biased toward issues rated below investment grade (30%). Low-rated preferreds issued by banks are precisely the types of preferreds that risk-adverse preferred stock investors have viewed as lower quality investments since the Global Credit Crisis began in June 2007.

While investing in a fund is more convenient, is it enough so to give up the benefits of building your own preferred stock portfolio?

By building your own portfolio you can pick and choose the highest quality issues, but you’ll have to figure out which ones to buy and do so over a longer period of time.

I took a look at these two alternative approaches to preferred stock investing since the Lehman Brothers collapse on September 15, 2008. Since that watershed event, the market has seen both extreme downward and extreme upward movement so I thought it would provide an interesting study period.

I define high quality preferred stocks (“CDx3 Preferred Stocks”) as those that meet the ten selection criteria from my book, Preferred Stock Investing (e.g. rated investment grade, issued by a company that has never suspended dividends, have cumulative dividends and have yet to reach their call date).

This chart compares the price performance of these two very different preferred stock investing strategies (building your own portfolio of high quality preferred stocks versus investing in shares of the iShares PFF fund) since the Lehman collapse on September 15, 2008.

Higher quality preferred stocks fell far less than poorer quality issues at the bottom (-17% compared to -33%) and have gained much more ground since then (+40% compared to +20%). That’s about half the downside and twice the upside by building your own portfolio of the highest quality preferred stocks.

But what about the time it takes to find just the highest quality preferred stock issues out of the 1,000 to 2,000 that are trading every day? My book, Preferred Stock Investing, explains how to screen, buy and sell the highest quality preferred stocks. All of the websites and other resources needed to do so are included.

But for those who would rather someone else do the research and calculations, I offer the CDx3 Notification Service. We do the research, you make the decisions.

Many Happy Returns.