Market Participant has a post up at ETF Investor about the need for a preferred stock ETF. I'm going to disagree for a couple of reasons.
The first reason is about investment merit and characteristics. ETFs help with single stock risk. The risk taken by owning a single-issue investment grade preferred stock is, reasonably speaking, quite low. The driver of volatility in a preferred stock is the maturity date and/or the call dates. This is easily controlled.
What about Enron and Worldcom like fraud? Well since those two how many fraudulent blowups have there been? Very rarely in history do investment grade companies go away due to fraud, it is statistically insignificant.
The other obstacle, more trading oriented, is liquidity of most preferred stock. The manager of a CEF can factor in liquidity and take time entering a position or get shares of a new issue if need be. An ETF provider needs to be able to meet creation-unit demand. To create shares of the ETF, the provider needs to either buy shares of the component holdings or buy futures on the way to buying the shares.
There are no futures or options for preferred stock. Buying a bunch of preferred stock in a reasonably short time period would be very difficult if not impossible. Most of the time there are just a few hundred shares offered for sale.
I mentioned CEFs up above. Look at the chart action of some of the preferred stock CEFs and you will see the most of the funds are more volatile than the underlying holdings. This is because the market price can swing wildly, in relation to NAV. An individual issue has its par value it has to go back to a CEF does not.
Proud Member Of
Random Roger
© 2009 | Gadget Theme Blogger Template
Original WPtheme By Blogger Template | Converted By Gadget Lover
| Distributed by eFree Blogger Help
Original WPtheme By Blogger Template | Converted By Gadget Lover
| Distributed by eFree Blogger Help
5 comments:
Market Participant is usually knowledgeable about this kind of thing, so I may be wrong.
But, wouldn't it make sense to wait and see if the 15% tax rate on all dividends is made permanent?
If we revert to the old tax code, only corporations will get the 15% rate on preferred dividends. This results in good returns for corporations, bad for individuals.
OG
The preferred stock CEF's from Flaherty/Crumrine, are hedged.
The flattening yield curve has caused those hedges against steepening yield curve to lose money.
Roger, I think you may be slightly misunderstanding the ETF creation process. To purchase a creation unit, an Authorized Participant, must show up already owning the securities in the creation unit. All creation transactions are "in kind". The A/P trades his securities for ETF shares and vice versa. Because the ETF never sells shares, it doesn't incur capital gains.
The burden of dealing with illiquidity falls on the Authorized Participant's not on the ETF sponsor.
You make a good point. I think this type of product would be unpopular vs the actual preferreds.
As a type of product I suppose they could become less popular if the 15% gets taken back but the investment attributes of yield and usually low volaility would not change after the initial reaction to bad news.
Bigger picture I am all for new products but I think the Preferred ETF misses the boat
to MP,
OK so liquidity is still a problem.
My first comment was in reply to OG
Liquidity is a problem for AP's it's not a problem for owners of ETF shares.
I don't see creation transactions occuring all that often. And some sort of index that includeds weighting by liquidity would solve part of that problem.
This sort of ETF will be held by buy and hold types. Merril Lynch publishes several preferred index's, and unlike traditional preferreds, the market for hybrid preferreds is pretty liquid.
Investors want a higher yeilding product than any of the bond ETF's out there.
Post a Comment