Tuesday, November 23, 2010

XPF – New iShares North American Preferred Stock Index ETF

Preferred shares are tempting for fixed income investors mainly because they pay higher returns than many other fixed-income investments. These higher returns come with the inevitable higher risks. BlackRock has helped to spread the risk by coming out with a new exchange-traded fund called XPF that tracks the S&P/TSX North American Preferred Stock Index.

The downside is the cost. The management fee is 0.45%, which is fairly high for an index ETF. The HST adds a little more: 0.03%. Then there is the currency hedging. Half the fund is invested in U.S. preferred shares and the currency exposure is hedged back to Canadian dollars. Such hedging usually seems to cause tracking errors in fund returns.

Another thing to consider is that while XPF has 120 underlying holdings, they are from a relatively small number of companies. For example, I counted 18 holdings of various Royal Bank preferred shares. Presumably, if there is risk of default on one Royal Bank preferred share, then they are all at risk.

For an investor who is only interested in the Canadian part of the ETF, a potential alternative investing strategy is to choose a few preferred shares from different companies and buy them directly. The limited universe of preferred shares means that XPF has limited diversification value over holding the preferred shares directly.

On the other hand, it certainly is more convenient to just buy XPF. Investors should likely be driven by costs here. An investor who works out the costs of XPF and the do-it-yourself approach for the anticipated size of investment can decide whether the annual additional costs of XPF are worth the convenience.

3 comments:

  1. I'm surprised that the U.S. only has 79 issuers of preferred shares. Am I the only one who thinks that number is low, at least compared to the size of the U.S. economy? Maybe it just takes prefs from mega cap companies.

    I agree with CPD. I prefer to hold preferreds individually, since I have a long term time horizon and can therefore avoid that half a percent MER.

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  2. @Thicken: Low trading volume can be a sign of a low number of outstanding units. If the market is avoiding a particular ETF, that may be a good sign that there are better alternatives. However, I prefer to do the analysis myself.

    @Financial Uproar: There aren't that many issuers in Canada either. This is why I think that an ETF of preferreds offers limited diversification.

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    1. The first reply above is to Thicken My Wallet's comment:

      I would like at the trading volume of all these new ETFs. Many of them are less than 100,000 a day. It is not a better mouse trap if no one will take it off your hands.

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