Market Pulse: A new variable rate ETF
May 21, 2014
A few years ago I spoke with an exchange-trade fund (ETF) representative at our local Starbucks and he asked me what would be a popular ETF to introduce.
My answer was an adjustable-rate preferred stock ETF. With rates sitting near historic lows, it's easy to see why a fund that would benefit from rising rates would be very popular.
The first-ever variable rate preferred stock ETF has just hit the market. I expect it will gather a lot of assets.
The Invesco PowerShares Variable Rate Preferred Portfolio (VRP) began trading on May 1. This fund offers dividend income that varies with interest rates, so its dividend payment will increase once interest rates rise. This should be a comfortable security to own for a long time.
What are the concerns? First, interest rates may remain low for a long time (think years). If so, this fund will underperform other fixed-rate equivalents. I don't yet know what VRP will yield, but I expect it to be fairly low.
Most adjustable rate securities are paying their minimum payments because interest rates are below their base-line amount. For that reason, rates would have to rise a lot for the payments to increase. As a result, many variable rate securities are trading as if they are fixed-rate securities.
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As for risk, VRP doesn't hold a diversified preferred portfolio. About 90 percent of their holdings are in the financial sector. The majority of securities held in this fund are S&P rated BBB or BB. Also, I suspect their largest holdings are fairly illiquid so this ETF may not handle high-dollar trades very well.
Readers of this column know that I like adjustable-rate securities because they are protected from large increases in interest rates. VRP is an easy way for investors to enter this market.
For my clients, however, I hold individual securities. That way we avoid paying the 0.50 percent management fee. Plus, I like holding securities tied to Treasury rates instead of LIBOR.
Feel free to call me or drop by my 889 Alder Ave. office to discuss adjustable rate securities in more detail.
David Vomund is an Incline Village-based fee-only money manager. Information is found at http://www.ETFportfolios.net or by calling 775-832-8555. Clients hold the positions mentioned in this article. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.
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