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PFXF ETF: 5% Yield with no bank exposure

By September 14, 2020 No Comments

The PFXF ETF from Vaneck is a preferred stock ETF that excludes financial stocks. We allocate to the PFXF ETF in our income based portfolios as it currently yields 5.69%. In this article we’ll highlight why we own PFXF and discuss its role  in different types of portfolio styles. A couple key things to know right off the bat is that PFXF pays interest monthly and has an expense ratio of 0.41%.

Why buy the PFXF ETF?

The main reason to buy the PFXF ETF is for yield. Interest rates are at record lows and are quite literally near zero for the safest US bonds. Every US Treasury with 5 years or less until maturity yields less than 0.30%:If you invest $10,000 in a 5-year Treasury bond, you’ll receive $25 in interest for the entire year, or a paltry $2.08 per month. The same investment in PFXF would provide $569 in interest per year, or $47.42 per month.

In addition to its high yield, the PFXF ETF has another trait we’re attracted to: it excludes financial companies. This is a relevant factor to us as we think banks could have a long post-Covid recovery.

This also allows us to better diversify our preferred stock portfolios. For instance, the PFF ETF from iShares has 62% of its portfolio allocated to financial institutions. Therefore, we can tactically pair instruments like PFXF and PFF together as we see fit, without creating fund overlap in the portfolio.

How does PFXF correlate to stocks?

Investors should understand that even though PFXF is an income producing vehicle, it has historically had a positive correlation to the S&P 500. This in contrast to something like TLT, a popular ETF that tracks the 20-year Treasury bond. TLT has had a negative correlation to the S&P 500 since its inception in 2002, making it a great diversifier versus equities in a portfolio.

From 2013-2019 (PFXF was incepted in July 2012), PFXF had a positive correlation of 0.45 to the S&P 500. So it has moved the same direction as the market, though with much less volatility. This correlation stands out even more when compared with more popular high yield ETFs like HYG, which has a lower yield and higher correlation to the S&P 500. The following graph shows key risk metrics for PFXF and HYG compared to the S&P 500 (via the SPY ETF):

The PFXF ETF compared to HYG & SPY since 2013

PFXF’s correlation to the S&P 500 is much lower than HYG’s (0.45 vs 0.70). In addition, its volatility (standard deviation) has been meaningfully lower than the SPY (6.02% vs 11.09%). And it’s max drawdown is lower than HYG’s over the period (-8.15% vs -9.47%). We find PFXF’s historical risk metrics appealing.

What risks are there with PFXF?

The PFXF ETF does not come without risks. There are two main risks to be aware of: interest rate risk and credit risk. When interest rates rise, fixed income products like PFXF tend to decline in value. That’s because fixed income products are interest rate sensitive: higher rates means lower prices.

To expand on this further, consider that TLT currently yields 1.20% which is near its lowest yield ever. At 1.20%, owning a 20-year bond may not be very appealing. But what if the bond yield rose to 2%? That would undoubtedly make the TLT ETF more competitive versus PFXF because investors would now be able to buy a safer fund and get higher yield than before.

PFXF performance in 2020

2020 exacerbated everything when it comes to analyzing risk factors, which is why our first chart only charted through 2019. But, we’ll show a few graphs here to help investors understand how PFXF reacted during the Coronavirus crash in March and then see if its gotten back to its more traditional way of behaving.

First, we show PFXF, TLT, and SPY for the year-to-date. We put TLT in place of HYG here to help display TLT’s role as a “safe haven” when the stock market was crashing in March:

The PFXF ETF compared to TLT & SPY in 2020

Thanks to the crash in March, when correlations across many different instruments ran extremely high, PFXF has a 0.96 correlation to the S&P 500 this year, compared to its historical correlation of 0.45. Note that TLT has a -0.63 correlation to the S&P 500 so far this year. Since May, which is when the unemployment rate first started to improve, PFXF has started to behave more in line with its historical risk metrics:

The PFXF ETF compared to TLT & SPY since May 2020

PFXF’s correlation to the S&P 500 has dropped to 0.67 (versus 0.96 year-to-date and historical of 0.45). And it’s volatility has declined to 9.94% (versus 26.43% year-to-date and historical of 6.02%).

Including PFXF in portfolios

The most compelling reason to buy the PFXF ETF is its 5.69% yield. This can provide a steady stream of income each month. In addition, we favor this type of preferred stock ETF over others because it excludes financial companies from its holdings, which is a sector we’re leery of having too much exposure to heading into 2021. Historically, PFXF has done a good job being a lower volatility source of income in a portfolio when compared to other income-producing securities like junk bonds or dividend stocks.

However, while not highly correlated to the S&P 500, PFXF is still positively correlated to the S&P 500 because it’s a bit of a hybrid between stocks and bonds, sharing characteristics with both. Keep this in mind because when the stock market crashes PFXF correlates more to stocks than it otherwise would, like we saw in March. Why does this matter? Well, if you’re a conservative investor you may want to keep securities like PFXF on the equity side of your portfolio allocation.

With that said, we typically include PFXF as an allocation on the bond side of our portfolio. Regardless of which side of your portfolio allocation you include PFXF in, we definitely think there’s a place for it. If including it on the equity side, consider using it to replace some exposure you may have to value, or dividend, stocks. If including it on the bond side, consider pairing it with a US government bond ETF like TLT.

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