An investment in knowledge pays the best interest. – Benjamin Franklin
The volatility in stock markets may not suit the appetite of many investors, and the low interest rates make debt instruments less attractive. For investors looking to strike a balance between these two asset classes, Invesco Preferred Portfolio ETF (PGX) may just be the most appropriate option. The fund offers investors with a very good yield and has exposure to names some of which can be considered “Too Big to Fail”. Below will explain why investors should give the ETF a look in order to enhance their investment returns.
Underlying holdings of the ETF
In the table below we have summarized the exposure to different counterparties by their percentage holdings. The fund has instruments of 142 names and can, therefore, be considered as a highly diversified portfolio. The top 10 names contribute about 39% of the total fund value and are either investment grade or very close to it. The entire portfolio, in fact, has a rating profile similar to what is seen within the top 10 holding names.
Wells Fargo & Co. (NYSE:WFC)
Bank of America Corp. (NYSE:BAC)
JPMorgan Chase & Co. (NYSE:JPM)
AT&T Inc. (NYSE:T)
Morgan Stanley (NYSE:MS)
Public Storage (NYSE:PSA)
Capital One Financial Corp. (NYSE:COF)
Citigroup Inc. (NYSE:C)
Southern Co./The (NYSE:SO)
Qwest Corp. (NYSE:CTV)
The speculative ones in both rating categories are AT&T Inc. (T), Morgan Stanley (MS), and Citigroup Inc. (C). All of these companies are renowned names with a healthy cash balance and there should not be any difficulty in meeting their near-term obligations towards fixed income instruments.
Source: Yahoo Finance
All figures in billions
While one may argue that the high cash balance is on account of deposits from banking activities for the financial institutions, it is unlikely that the account holders would be pulling out their money from such banks. These banks also need to meet certain reserve requirements in order to ensure that depositors are not affected.
One should also consider the fact that the potential for higher returns offered by these names seems appropriate for the risk taken. Moreover, these companies are only a notch below the investment grade category and better performance in the future could bring them back to the investment grade category.
Other features of this ETF
A substantial dividend yield: The dividend yield of the fund stands at 5.24% which is close to the weighted average coupon of the fund. It makes sense since any payments from the instruments are distributed to the shareholders in the form of dividends.
Some of the instruments having an “A” rating offer a rate of interest as high as 6.25% since these were purchased at a time when the rates were high. That high of a yield might not come back as rates continue to fall, but the ETF is an attractive option in this environment.
Assured Guaranty Municipal Holdings Inc. (NYSE:AGO.PE)
Entergy Texas Inc. (NYSE:EZT)
Entergy Arkansas LLC (NYSE:EAB)
Entergy New Orleans LLC (NYSE:ENO)
Entergy Louisiana LLC (NYSE:ELJ)
Entergy Louisiana LLC (NYSE:ELC)
Entergy Mississippi LLC (NYSE:EMP)
Entergy Arkansas LLC (EAB)
A reasonable level of interest rate risk: The effective duration of the ETF stands at 4.50 years which is at a moderate level as far as interest risk is concerned. The fund offers investors the flexibility of choosing a diversified portfolio with a tenure that is not too long. For someone looking to directly invest in such fixed income securities, it would be an impossible task to track so many instruments spread across hundreds of issuers.
Fees and NAV: The management fees of 0.50% is justified given the level of due diligence required and the expertise involved in selecting instruments that meet the goals of the fund. The total expense ratio stands at 0.52%. The NAV of the fund is at $14.49 against the market price of the stock at $14.51 illustrating that the fund is appropriately valued.
Risk Factors to be considered
Credit Risk: A significant portion of the ETF is invested in Speculative Grade investments and the probability of defaulting on the coupon or principal payments cannot be discounted. The impact of the pandemic may cause a large number of names to default and this may lead to a drop in dividend yield. We could also see some of the investment grade counterparties fall below this category and the rate of interest, in this case, would not justify the risk taken. It should also be noted that the claims in these instruments are subordinate to debt.
Interest Risk: While we have discussed the effective duration of the fund being reasonable, one must consider a scenario in which the rates are actually rising. We are already at a stage during which interest rates are at their lowest level. The possibility of a hike would be realistic once green shoots emerge in the economy. We have seen how falling interest rates helped the stock price rally and a sharp fall in price would follow if rates rise.
Difficulty in tracking: The fund has a large number of instruments and following the development of each one can be difficult even for an expert fund manager.
Invesco Preferred Portfolio ETF offers a good portfolio of preferred securities comprising of market leaders that have been meeting their debt obligations. The fund is suitable for investors looking to take on some amount of credit and interest rate risk in return for higher yields.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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