Playing a Preferred Financial ETF

PowerShares Capital Management just listed the PowerShares Financial Preferred Portfolio(PGF).

Although it might be tough to say the name 10 times fast, the concept is simple to grasp: The exchange-traded fund owns preferred stocks from financial companies, both foreign and domestic, that all qualify for the 15% qualified tax rate.

I've lately received some questions and comments from readers regarding how to structure the fixed-income portion of a portfolio. Most investors have some allocation to fixed income but do not spend enough time managing it.

One part of the puzzle that I like and use for clients is preferred stock. Many preferreds are on the NYSE, so they are easy to trade, and the dynamics are such that they are individual-investor friendly.

Finding the credit ratings is easy to do, so you know what you are getting, and safe yields can be found around 6%.

While this might sound easy, there are do-it-yourselfers who are not comfortable picking individual preferreds. Those folks might have previously sought out a closed-end fund to invest in this segment, but I believe the ETF structure could be a better way to go.

The chart below compares the market price with the net asset value (NAV) for the Nuveen Quality Preferred Income Fund(JTP), a closed-end fund.

As you can see, the market price has been much more volatile than the NAV as investors overreact to swings in interest rates in both directions.

The structure of an ETF takes this sort of divergence, and therefore probably the volatility, off the table. Most investors want a fixed-income product that does not move around a lot and just pays the income.

Nuveen Quality Preferred Income Fund Market price vs. net asset value