New Preferred-Stock ETF Seeks to Avoid Financials

Prescott, Ariz. (TheStreet) -- Van Eck recently launched what could be a very useful fixed-income product with the Market Vectors Preferred Securities Ex-Financials ETF (PFXF).

iShares recently launched a couple of bond ETFs that also exclude financial stocks, and there will probably be other fixed-income products in the future that avoid financials.

The big idea is that anyone concerned that the financial crisis is not over and wants to avoid banks can do so with funds like PFXF. Financial companies issue the most debt by far, including preferred stocks, and it can be very difficult for investors looking to avoid that sector for their fixed-income portfolios to do so and still be able to use ETFs.

As someone who does not like financial stocks but who uses preferred stocks for clients, this fund immediately caught my eye. The fund has 67 holdings, a good number for reasonable diversification, but there are some quirks in the composition of the fund that may detract from what is a great idea.

The average current yield of the holdings is 6.78%, which, after accounting for the 0.40% expense ratio, leaves yield to fund holders at possibly 6.38%. But as is always the case with ETFs, the actual yield of the fund remains to be seen and can fluctuate from what investors expect.

The Van Eck website reports a 10% weighting to General Motors' ( GM) preferred B shares, which is far higher than the 3.76% to an issue from PPL Corporation ( PPL), which is the second-largest holding.

Other than the GM issue the larger weightings in the fund are in the 3% range, with smaller holdings closer to 1% -- which makes the 10% in GM all the more puzzling. The screening methodology combines market-cap weighting of the issues and liquidity and this process allows for GM preferred B to have a 10% weighting.

Also surprising is a very narrow definition of financial stocks that appears to be limited to banks. PFXF includes reinsurance companies and various types of REITs, including a couple of positions in mortgage REIT preferred stocks. Preferreds from these companies appear to account for 36% of the fund; 6% reinsurance, 30% REITS.

The index that underlies the fund is constructed and managed by Wells Fargo ( WFC), which believes the businesses of REITs and reinsurers is not the same as other financials, which allows for them to be in the index and so in the fund.

To be clear, there are no bank preferred stocks in the fund. Anyone interested in this fund needs to decide whether their own definition of financial companies includes insurance companies and REITs.

One of the holdings in the fund is Vornado Realty Trust 's ( VNO) Preferred Series I. VNO-I began trading in 2005 and during the worst of the financial crisis dropped 45% ,which although better than most issues from the large banks was far worse than the slow and steady 5% gain for Dominion Resources' ( D) preferred stock, another holding in the fund, during the financial crisis.

Although that is just one example, I believe that REITs and insurance companies are financials and also believe that a preferred stock fund that really excludes all financials is a great idea. While a repeat of 2008 is very unlikely, if it happens then PFXF is likely to drop meaningfully in value.

At the time of publication the author had no positions in the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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