Preferred Stocks

As of September 2012, the preferred stock market was valued at $500 billion. The yield of the S&P U.S. Preferred Stock Index was 6% versus ~2% for the S&P 500. These hybrid securities often have a call feature. Some preferreds can be converted to common stock. But just like common stocks, the dividend can be cut or cancelled without notice by the company’s board of directors. 

 

During the financial crisis, the preferred stock index fell 63% from July 2008 to the market low in March 2009. Over the same period, the S&P 500 dropped 46%. This greater loss was largely due to the fact that many preferreds have a junk rating. Banks and other financial firms issue most preferreds. Financing for these companies is no problem during decent economic times, but money can dry up when credit is tight.

 

As a generality, just 5–10% (or less) of a client’s fixed-income portion of a portfolio should be considered for preferreds. Examples of preferred funds include: PowerShares Preferred ETF, Market Vectors Preferred Securities ex-Financials, Global X “Super Income” Preferred ETF, and iShares S&P Preferred Stock Index.