Be sure to also see the 7 Questions to Ask When Buying a Mutual Fund.
A Primer on Preferred Stocks
As for the bond side, preferred shares have a fixed guaranteed dividend amount, which is paid out before payments to common stockholders. These payments are often much higher than the regular dividend payments on the firm’s common shares. Also making preferred bond-like is that they have a par value. Just like bonds, these shares are issued at a certain amount – usually $25 or $1000 per share. Due to market forces, they can trade at premiums or discounts to that amount. Like bonds, preferred stocks come with a maturity date, which means the issuing company can retire the security at par for investors.
The cons for the share structure are that investors lack voting rights—which are granted to common stockholders-and there is capped upside due to callability at its par value. Common shares can essentially go up forever.
See also Beginner’s Guide to Bond Mutual Funds.
Even given those small cons, preferred stock can be a great position to have in your portfolio. The most obvious upside is income potential. With yields in the 5% to 8% range, preferred securities can be the cure for low interest rates. They can also be a powerful total return tool. Remember, these shares can trade for below their par value. By scooping up shares below par, investors can profit when they are called. Buying a preferred share at $20 and having it called at $25 is an easy 25%. And that’s not including the dividends you’ll collect.
Why Preferred Stock Mutual Funds Are Best
By buying preferred stock through a mutual fund, retail investors leave the hard work to the professionals, who can research and find the best yields as well as candidates for capital gains. Additionally, by buying a preferred stock mutual fund, investors are able to spread their capital among a multitude of individual issues rather than just buying one or two preferred stocks. This helps in the event of a potential blow-up.
Additionally, by using a mutual fund to own preferred stocks, investors can get a break on the tax front. Unlike common stocks, not all preferred stock dividends qualify for the lower tax rate – currently at 15%. Investors—given the lack of available research—could be setting themselves up for a nasty tax bill if buying individual preferred stocks. Many preferred stock mutual funds state in their mandates that they will seek securities that qualify. Also, many managers can and do seek to minimize the effects of capital gains when shares are called.
Preferred Stock Mutual Funds to Consider
Expenses for CPXAX are lower than the category average at 1.10%. However, the fund does charge a 3.75% sales load for A shares. The minimum investment in the preferred stock fund is $1,000.
Principal Preferred Securities A (PPSAX): PPSAX is the oldest mutual fund dedicated to preferred securities – first launching in 2002. It’s also one of the largest funds in the sector. Management tends to trade down the credit ladder and run the entire gamut of preferred stock types in order to pick up a few more percentage points of yield. About 90% of its portfolio is rated BBB or BB. This creates a juicy 5.01% yield.
Expenses for PPSAX run 1.07% and there is a 3.75% front-end load on A shares.
Nuveen Preferred Securities A (NPSAX): For investors looking for some international flair to their preferred stock portfolio, NPSAX offers exposure to “Yankee” preferreds issued overseas. The Yankee Bond Market consists of U.S. dollar-denominated, publicly issued debt of non-U.S. corporations, foreign government debt, and supranational debt. About 33% of NPSAX’s portfolio is in Yankee preferreds.
That focus on some international issuers has given the mutual fund a slight edge in the returns department. NPSAX managed to produce an 11.9% total return over the last five years. Currently, the fund yields 4.86%. Expenses run 1.07% and come with a 4.75% front-end load.
The Bottom Line
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