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There are currently only 5 significant ETFs in the preferred and convertible ETF sector. More may be issued naturally especially as the drive for yield heats up with baby boomers heading toward retirement and some distrust of equity market conditions. Preferred shares are senior to common stock and entitled to dividends ahead of the former. Many have credit ratings like bonds. These shares also protect investors to some extent in the event of a company liquidation or merger. Also preferred stock may have a redemption clause (callable) beneficial to the company issuing them. These callable factors would generally limit the appreciation normally seen with common stocks. The trade-off is higher yield for capital appreciation. Also, in the event a company seeks to issue more preferred shares in the future at a price lower than existing issues the price will be lowered on the subsequent stock sale.

Preferred stocks may be an attractive alternative financing tool for corporations. This may allow companies to go into arrears without a penalty common to bond issues. Preferred issues may be in place to prevent a hostile takeover.

Banks may use preferred shares as a form of Tier 1 capital which is the core measure of a bank's financial strength. This generally consists of common stock and disclosed reserves but may include various preferred stock shares.

In addition some preferred shares may have any or all of the following attributes: a voting rights agreement; registration rights; the right to receive financial statements; preemptive rights on future stock financings; and rights of first refusal on sales of founder stock and so forth.

As we've seen with an investor like Warren Buffet he has asked for and received a special class of convertible preferred shares particularly when investing in troubled companies like Goldman Sachs and Bank of America to name two. Of course, these are shares issued exclusively to his Berkshire Hathaway company and unavailable to the general investing public other than through BRK/A or B.

Currently financials and banks dominate the holdings of ETFs in the preferred space. This should act as a note of caution. Previously public utilities to dominated the space but that's not how current indexes are constituted or weighted.

We rank the top 10 ETF by our proprietary stars system as outlined below. However, given that we're sorting these by both short and intermediate issues we have split the rankings as we move from one classification to another.

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Strong established linked index

Excellent consistent performance and index tracking

Low fee structure

Strong portfolio suitability

Excellent liquidity

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TheStreet Recommends

Established linked index even if "enhanced"

Good performance or more volatile if "enhanced" index

Average to higher fee structure

Good portfolio suitability or more active management if "enhanced" index

Decent liquidity

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Enhanced or seasoned index

Less consistent performance and more volatile

Fees higher than average

Portfolio suitability would need more active trading

Average to below average liquidity

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Index is new

Issue is new and needs seasoning

Fees are high

Portfolio suitability also needs seasoning

Liquidity below average

We feature a technical view of conditions from monthly chart views. Simplistically, we recommend longer-term investors stay on the right side of the 12 month simple moving average. When prices are above the moving average, stay long, and when below remain in cash or short. Some more interested in a fundamental approach may not care so much about technical issues preferring instead to buy when prices are perceived as low and sell for other reasons when high; but, this is not our approach.

Premium members to the ETF Digest

receive added signals when markets become extended such as DeMark triggers to exit overbought/oversold conditions.

For traders and investors wishing to hedge, leveraged and inverse issues are available to utilize from ProShares and Direxion and where available these are noted.



Convertible Bond ETF (CWB)

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is linked to the Barclays Capital U.S. Convertible Bond > $500M Index which follows only those issues with issue sizes great than $500M.

The issue was launched in April 2009. The expense ratio is .40%. AUM equal $744M with average daily trading volume of 211K shares. The constituents include convertible bonds and preferred stocks. As of late January 2012 the annual dividend yield was 3.53% and YTD return 5.50%. The one year return was -4.77%

Data as of First Quarter 2012

CWB Top Ten Holdings & Weightings

    Wells Fargo & Co, San Francisco Ca Pfd: 3.92%

    General Mtrs Cv: 3.29%

    Citigroup Pfd: 2.70%

    Bank America Pfd: 2.62%

    Intel 144A Cv 3.25%: 2.45%

    EMC Corp Mass Cv 1.75%: 2.43%

    Amgen Cv 0.375%: 2.38%

    Metlife: 2.37%

    Chesapeake Engy Cv 2.5%: 2.18%

    Medtronic Cv 1.625%: 2.15%

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    Wells Fargo Preferred ETF (PSK)

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    follows the Wells Fargo Hybrid and Preferred Securities Aggregate Index which is a

    modified market capitalization weighted index composed of preferred stock and securities that are functionally equivalent to preferred stock including, but not limited to, depositary preferred securities, perpetual subordinated debt and certain securities issued by banks and other financial institutions that are eligible for capital treatment with respect to such instruments akin to that received for issuance of straight preferred stock.

    The fund was launched in September 2009. The expense ratio is .46%. AUM equal $132 million and average daily trading volume is 16K shares. As of late January 2012 the annual dividend yield is 7.06% and YTD return 4.08%. The one year return was 4.91%.

    Data as of First Quarter 2012

    PSK Top Ten Holdings & Weightings

      Barclays Bank PLC (BCSPRD): 2.25%

      HSBC Hldgs Pfd: 2.18%

      Wells Fargo & Co, San Francisco Ca Pfd: 2.00%

      Credit Suisse Guernsey Brh Pfd: 1.80%

      Metlife Pfd: 1.77%

      Deutsche Bk Contingent Cap Tr Iii Pfd: 1.54%

      Goldman Sachs Grp Pfd: 1.52%

      Ing Group N V Pfd: 1.51%

      AT &T Pfd: 1.48%

      Wells Fargo Cap Xii Pfd: 1.35%

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      Preferred ETF (PGX)

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      tracks the BofA Merrill Lynch Core Fixed Rate Preferred Securities Index. The fund was launched in January 2008. The expense ratio is lower at .50%. AUM equal $1.4 billion and average daily trading volume is 457K shares.

      As of late January 2012 the annual dividend yield is 6.78% and YTD return was 3.71%. The one year return was 7.20%.

      Data as of First Quarter 2012

      PGX Top Ten Holdings & Weightings

        Wells Fargo & Co, San Francisco Ca Pfd: 5.00%

        Citigroup Cap Xiii Pfd: 4.67%

        JP Morgan Chase Pfd: 4.17%

        Barclays Bank PLC (BCSPRD): 4.15%

        Citigroup Cap Xii Pfd: 4.06%

        HSBC Hldgs Pfd: 3.65%

        Morgan Stanley Cap Tr Vii Pfd: 3.34%

        HSBC Hldgs Pfd: 3.32%

        General Elec Cap 6.1%: 3.00%

        Bank of America Pfd: 2.96%

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        Financial Preferred ETF (PGF)

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        tracks the Wachovia Hybrid & Preferred Securities Financial Index. The fund was launched in December 2006. The expense ratio is .60%. AUM equals $1.5 billion and average daily trading volume is roughly 355K shares. Quality ratings put most of the assets in the A to BB category. As of late January 2012 the annual dividend yield was 7.62% and YTD return 6.81%. The one year return was 3.97%.

        Data as of First Quarter 2012

        PGF Top Ten Holdings & Weightings

          HSBC Hldgs Pfd: 10.43%

          Bank Amer Pfd: 7.24%

          HSBC Hldgs Pfd: 6.12%

          Ing Group N V Pfd: 5.15%

          Wells Fargo & Co, San Francisco Ca Pfd: 4.85%

          Metlife Pfd: 4.68%

          Credit Suisse Guernsey Brh Pfd: 4.62%

          JP Morgan Chase Pfd: 4.61%

          Bank Amer Pfd: 4.51%

          Ing Group Nv Pfd: 3.41%

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          U.S. Preferred Stock Index (PFF)

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          tracks the index described parenthetically. The Fund was launched in March 2007. The expense ratio is .48%. AUM equal $7.4 billion with an average daily trading volume of 1.2M shares. As of late January 2012 the annual dividend yield is currently 6.66% and YTD return 5.98%. The one year return was 3.48%.

          Typically, with most preferred issues you'll find mostly financial company names as index constituents. PFF is no different with nearly 85% of holdings from financial companies. This concentration is a risk factor investors need to consider.

          Data as of First Quarter 2012

          PFF Top Ten Holdings & Weightings

            HSBC Hldgs Pfd: 2.59%

            General Mtrs Cv: 2.35%

            Barclays Bank PLC (BCSPRD): 1.64%

            Wells Fargo & Co, San Francisco Ca Pfd: 1.61%

            Citigroup Cap Xii Pfd: 1.52%

            Citigroup Cap Xiii Pfd: 1.52%

            HSBC Hldgs Pfd: 1.47%

            Bank Amer Pfd: 1.43%

            JP Morgan Chase Cap Xxvi Pfd: 1.29%

            GMAC Cap Tr I Pfd: 1.28%

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            The sector is primarily for yield hungry investors of which there is a growing segment. The sector has recovered from its recent lows as of January 2012. This is due to more confidence in an economy that may be turning higher encouraging bulls believing financials in particular have bottomed. But we've seen this before and how long this belief will last is uncertain.

            It's also important to remember that ETF sponsors have their own competitive business interests when issuing products which may not necessarily align with your investment needs. New ETFs from highly regarded and substantial new providers are also being issued. These may include Charles Schwab's ETFs and Scottrade's Focus Shares which both are issuing new ETFs with low expense ratios and commission free trading at their respective firms. These may also become popular as they become seasoned. 

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            The ETF Digest has long positions in PFF and PGF in various portfolios.

            (Source for data is from ETF sponsors and various ETF data providers)

            This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

            Dave Fry is founder and publisher of

            ETF Digest

            , Dave's Daily blog and the best-selling book author of

            Create Your Own ETF Hedge Fund, A DIY Strategy for Private Wealth Management

            , published by Wiley Finance in 2008. A detailed bio is here:

            Dave Fry.