Preferred ETF’s stocks and funds , the high yielding hybrids of common stocks or corporate stocks , are highly appealing for profit – hungry investors.  Even though these average yield of 6-7 percent is spectacular but the mutual and exchange traded funds often come with trade-off that demand a closer scrutiny of them.

As compared to ordinary stocks , they have a preferred status as they not only provide a generous flow of income similar to high-yielding bonds , they also are less volatile. For instance , during the crisis in 2008 , the Preferred Stock Index of the $8.5 billion iShares S&P  lost two third of the loss suffered by the S&P 500’s normal stock index.

Besides that the companies are supposed to be paying dividends to the holders of preferred stocks before it is paid out to the common stock holders, which specifies the “preferred “ label , while they are taxed at favorable tax rates of 15 percent. However , these stocks do not have too much of an appreciation potential.

In the times of interest rates being stable or declining , preferreds have been the most attractive options. The return of the iShares S&P Preferred Stock Index has been 22 percent when annualized over the three year period , boosted by the recent yield of six percent and inclination towards the financial sector services . The yield is 2 % points more than the S&P 500 over the same period and 5 points better than the yields of average of high-yield bond funds.

However in return of the kick they get in yields , they have to shoulder the risks seen by bond investors. Preferred stocks are sensitive to interest rates  and unlike the case of bonds , they either never reach maturity or in most cases return the principal after a time span of 30-50 years. When interest rates hike , pricing of preferred stocks fall , and investors could be well stuck with lower-valuation paper that the issuers might never redeem.  

In the times of stock rise , preferreds have limited upside because of the redemption rights possessed by the issuers. The rights include , provisions for a “call” where in the issuers can buy out at face value after five years of the date of issue.  In case of decline in interest rates , the chances for buying out increase as they can issue fresh securities for a lower yield.

Another risk that should be considered is the “credit risk “ . With most of the issuers being big banks which are considered as “too big to fail” , issuer competitiveness in the current economy should be considered. In case of troubles , their dividends can be suspended . While in cases of bankruptcy , much like bond holders, they will be out of luck.