VanEck Preferred Securities ex Financials ETF (NYSEARCA:PFXF) primarily invests in preferred securities which typically offer high yields, however it does so while avoiding banks and other financial stocks. This ETF has about $1.69 billion in assets under management and offers a low expense ratio of 0.41%. The 30-day SEC yield is 6.76%. Since its inception in July 2012, this fund has returned nearly 5% annually. However, the one-year total returns of just over 10.8%, could be more of what we see for the next couple of years. It’s important to remember that the 10-year returns were significantly impacted by one of the worst periods for preferred securities and bonds because of the massive rate tightening cycle of the Federal Reserve. That tightening cycle appears to be over, and rate cuts could be coming which makes this ETF a candidate for a high yield and potential capital gains over the next couple of years. I think the omission of financial stocks is a big positive and will get more into why below. Let’s take a closer look:
The Chart
As the chart below shows, this ETF went down to about the $15 level in October last year. However, since then it has been in a general uptrend. The 50-day moving average is around $17.23 and the 200-day moving average is $16.67. I think pullbacks to these key support levels would make for ideal buying opportunities.
StockCharts.com
As shown below, this ETF has a wide range of holdings across many industries. It owns preferred securities in many familiar companies such as AT&T (T), Ford (F), Ablemarle (ALB), NextEra Energy (NEE), Duke Energy (DUK) and more. These are all companies that I would be comfortable owning stock in, so I am also happy to own preferred securities in these names as well. The largest holding is just over 5% of the portfolio, and most positions represent just 2% to 3% of the portfolio, which shows this ETF is broadly diversified and not taking on big risks from any single position.
Top Ten Holdings
Source: Seeking Alpha
The Dividend
This ETF pays a dividend that varies in terms of the timing and amount. As noted above, here is the latest dividend data: the 30-day SEC yield is 6.76%, the distribution yield is 7.38%, and the 12-month yield is 7.53%.
Why Excluding Financial Stocks Could Be A Great Strategy
The banking system has had issues for the past couple of years, and the challenges facing this sector remain and could get worse in the future. The biggest problems in the past couple of years have been from bond losses, which were a result of the Federal Reserve’s aggressive rate hiking cycle. This problem remains but could improve if the Federal Reserve starts to lower rates. However, some potentially big problems could still lie ahead because of the commercial real estate market which has seen huge declines in values, which is also a result of the much higher interest rates. The losses for banks with commercial real estate could become a major problem in the months ahead as many fixed rate loans become due. This could result in a wave of defaults and foreclosures in the coming months and create big loan losses for the banks.
A recent article by Desmond Lachman sums up the risks in the banking sector, and it states:
“Adding to the banks’ troubles is a commercial real-estate crisis as a result of soaring vacancies in a world where people increasingly work from home and shop online. Office prices are estimated to fall by at least 40% from their 2022 peak. That together with high interest rates will make it well-nigh impossible for property developers to roll over the $930 billion in maturing property loans this year without a major debt restructuring.
A wave of commercial-property defaults at a time of already-stressed balance sheets will be particularly problematic for the regional banks, which have close to 20% of their loan portfolio tied up in commercial-property lending. A recent National Bureau of Economic Research study estimates commercial-loan problems could lead to the failure of nearly 400 banks.”
For all the reasons above, I think it makes sense to avoid the banks and other stocks in the financial sector. Banks are highly leveraged business models that can work fine for many years, but can also easily see major losses or a complete wipe out of their capital during economic downturns. I stopped investing in banks years ago for this reason and would only likely consider a bank stock as a short term trade, if anything at all.
Why PFXF Could Outperform In the Next Couple Of Years
Obviously, I think PFXF can outperform its peers because most preferred stock ETF’s have heavy exposure to the banking and financial sector. I think the financial sector will remain challenged for at least a couple more years and possibly longer, if the economy goes into recession. The banking sector could potentially see large losses in a recession and with red flags showing up for this sector and with signs that the economy is slowing down, it makes sense to be disciplined and reduce risks that can come from exposure to financials.
Whether or not we see a recession, it looks like interest rates are going to decline in the next couple of years, and this is according to the Federal Reserve’s own forecasts which were just updated on June 12, 2024. These forecasts suggest that the Fed Funds rate will drop by about 40% from the current level of roughly 5%, down to around 3%, in 2026. This means money market yields could drop to similar levels and this might cause a new chase for yield whereby investors bid up prices for preferred securities. This could generate capital gains for investors who lock in the current prices now, while yields are still relatively high. I believe it is just a matter of time before rates come down substantially, and this will either happen because the Federal Reserve lowers rates, or it will happen because rates were kept too high for too long, creating a recession, in which rates go down because the economy is weak.
What I Like About PFXF
This ETF has offered strong total returns over the past year, and I believe similarly strong gains could be in store for the next couple of years. I believe it is hugely positive that this ETF avoids the financial sector completely and yet it is still able to offer the higher yields that investors expect from preferred securities. I like the broad diversification across a range of industries and the fact that it does not have any outsized positions that could lead to increased downside risks.
Potential Downside Risks
If there is a risk-off correction in the markets, even preferred securities will likely drop in value even though they are generally a lower risk asset when compared to stocks. When the stock market correction occurred in 2020 because of Covid shutdowns, this ETF plunged along with the market and other preferred securities ETF’s. However, this ETF quickly recovered along with other risk assets. But, the Covid plunge shows the potential downside risks when investors are panicked, and for this reason, I would never make this a large position in my portfolio.
In Summary
I think PFXF is a solid buy here, and even more so on pullbacks. The yield of about 7% is hard to beat now, and will be even more attractive when rates likely decline in the next couple of years. The lack of exposure to the financial sector is another big positive for me. I see this ETF as an ideal addition to my portfolio, as I work to deploy cash that I currently have in money market funds, since the yields are likely to drop in the coming years, while this ETF could see capital gains along with a yield that already beats money market yields.
No guarantees or representations are made. Hawkinvest is not a registered investment advisor and does not provide specific investment advice. The information is for informational purposes only. You should always consult a financial advisor.
