It’s little surprise that income hunters have turned to preferred securities—hybrid investments that are part bond, part stock. Over the first nine months of 2012, investors poured $518 million more into PowerShares Preferred Portfolio (symbol PGX) than they took out. Their interest wasn’t a surprise in light of the exchange-traded fund’s hefty 6.5% yield.
In response, PowerShares decided to adopt a broader underlying index—the BofA Merrill Lynch Core Plus Fixed Rate Preferred Securities index—to expand the available choices of preferreds. The new benchmark allows the fund to invest in companies with below-investment-grade ratings (double-B and lower), a category its previous index barred.
The move doesn’t appear to have made the ETF appreciably riskier, at least in comparison with its biggest rival. More than half of PowerShares’ assets sit in investment-grade preferreds; 39% are in preferreds rated double-B and lower, as well as unrated issues. By contrast, iShares S&P U.S. Preferred Stock Index has 45% of its assets in investment-grade preferred shares, 35% in junk-rated securities and 20% in “other.”
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But preferreds come with other risks. Most are issued by financial firms. Plus, they typically lose value when interest rates rise. But with the Federal Reserve pledging to keep rates down indefinitely and the financial sector in recovery, preferred-stock ETFs look appealing.
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