Preferred-Stock ETFs Shine

While this hierarchy provides a more reliable payout structure for preferred ETF holders, it will not protect investors to the extent that an investment in bonds would. This protection is a key consideration for investors wary of PGF components such as Bank of America(BAC Quote), JP Morgan(JPM Quote), Wells Fargo(WFC Quote) and ING Group(ING Quote).

The ongoing stress in the financial markets makes both debt and equity investors more vulnerable to losses. As common shareholders see a dilution in their stock, particularly in that of financial institutions, as shares are pumped into the market to increase financing, it is likely that preferred structure will stay intact.

There has been some talk about a reduction in the tax advantages of preferred shares as federal deficits continue to grow. Even if the tax rate were increased on preferred payouts, however, it is still likely that the tax structure would remain advantageous to regular capital gains.

PGF, PFF and PGX have rallied significantly since the lows of late 2008 and are nearly at the levels seen in October before the worst of the financial crisis. Why, then, should people buy preferred funds now when common stock could have a larger upside potential?

The fear caused by the financial collapse paralyzed investors who could not imagine buying into companies like BAC or JPM even if the yield appeared ridiculously high.

The recent upswing in the economy may have restored some faith in investors who are once again considering the market for high-yield funds. Prospective preferred ETF holders should purchase PGF, PFF or PGX for the right reasons -- as part of a larger strategy, for their potential to pay out regular dividends and likelihood to remain more tax-efficient than other instruments.