PFFA: Value and Growth Income ETF (NYSEARCA:PFFA)

Introduction

Given that the market is clearly wary of megacap stocks, income investors can actually embrace many interesting income alternatives. Virtus InfraCap US Preferred Stock ETF (NYSEARCA:PFFA) is an attractive income game that offers a 9% dividend. and featuring a unique portfolio with an infrastructure focus. These companies will get a much needed business boost as the rate cut cycle begins. Despite the non-investment grade credit rating (BBB-), I consider PFFA a buy given the friendly macro context and active management to address credit risks. Income investors may want to include it in their shopping list.

PFFA ETF Highlight

PFFA is an actively managed preferred stock ETF by Virtus, with an official fund description below:

The fund seeks current income and, secondarily, capital appreciation through a portfolio of preferred securities issued by US companies with market capitalizations. over 100 million dollars.

Unlike some of the sector-oriented preferred stock ETFs, the ETF has exposures to many major sectors except technology, as shown below. This is due to its infrastructure-centric approach to asset allocations. In fact, sectors such as Financials (27.8%), Real Estate (22.89%), REITs (19.09), Utilities (10.94%), Industrials (9.27%) are the sectors where quality favorite stocks are often found. Sector diversification increases portfolio breadth and reduces overall volatility.

There are 208 holdings in the portfolio. The following is the list of the top 10. These holdings are spread across financial banks, REITs, MLPs, etc., the sectors highlighted above.

This actively managed ETF uses leverage to improve returns and portfolio performance. The target leverage range is 20-30%, which is slightly lower than the average leverage used by CEF funds.

In addition, management also uses option strategies to increase income and hedge interest rate risk. As a result of the heavy activities, the ETF charges quite high fees, with an expense ratio of 2.52%.

However, the ETF offers high monthly dividend payments with a yield of 9.09%. This is the most attractive feature for income investors.

PFFA was launched on May 15, 2018. It has gained quite a bit of popularity in its relatively short history of about 6 years. AUM is at $1.17B currently with decent trading liquidity.

Favorite stocks benefit from macro tailwinds.

Preferred stock is often considered a “hybrid investment,” with market characteristics that illustrate a combination of common stocks and bonds. For example, preferred stocks behave like equity stocks, although much less volatile. On the other hand, they are sensitive to interest rate changes, similar to bonds. Therefore, preferred stocks are expected to get a boost from the highly anticipated rate cut in mid-September.

In addition, PFFA is highly leveraged, which will add a positive impact on profitability when the rate cut cycle begins. This is when the cost of debt will be reduced, and more importantly, the risky leverage should produce the correspondingly high return. In other words, the macro context seems to support the leverage approach, that’s the risk I’m willing to take for high-yield dividend income in actively managed ETFs, including the rate hedge option approach.

There are strong signals for recent growth.

In terms of stock characteristics, the PFFA portfolio showed very encouraging growth improvements. The following are the CAGR values ​​for the aggregation of all constituents in the portfolio. It can be seen that the total revenue is increasing by almost 700% year on year. Gross profit is increased by 522.1%. Note that these huge incremental growth rates are based on a very bad year prior to the current one. But they give strong signals for recovery in business growth in the covered sectors. Those companies selected by the ETF are likely among the best growth plays to be found in their respective industries.

I believe the most interesting growth for income investors should be dividend growth. If I were to just take the 5-year average of 8.5%, it would make this an impressive dividend growth “stock” almost since its inception (2018).

Please note that the PFFA ETF itself has not been able to illustrate similar dividend growth due to fund-specific volatilities caused by leverage and option overlap applied by the fund. But the increase in constituent dividends can certainly be seen as a basic insurance to maintain the high yield of PFFA.

Market rotation tailwinds will help overall performance.

PFFA’s share price has performed quite well in 2024. The following chart shows performance comparisons to the S&P500 and the HYG High Yield Bond ETF. PFFA’s overall performance has increased by 13.86% so far this year. That’s very close to the S&P 500’s 15.38% gain. On the other hand, HYG’s gain is only about half that at 6.67%. While it closely follows the mixed behavior of preferred stocks, as mentioned earlier, PFFA’s overall performance was closer to the upper end of the equity side, not the lower end of the bond side in 2024.

There is currently a “growth scare” in the stock market, which could be a catalyst for value swings in the coming months. I think investors will continue to move away from megacap growth stocks. The top sectors of the PFFA allocation, including financials, utilities and industrials, are the traditional “value” sectors. These are the sectors where I expect more money to flow in the near future. Preferred stocks will benefit from this type of market rotation.

The other two key sectors in the PFFA portfolio, Real Estate and REITS-Mortgage, are on track to recover in their own market, thanks to the promising rate cut. Preferred stocks in these sectors are also expected to be market winners during rotations.

In fact, the chart above has already shown some strong signals for rotations. PFFA has been on a relatively steady rise. Even during the recent stock market pullback at the end of July, PFFA just took a small dip then. The latest price action demonstrates a more compelling trend divergence between the PFFA and the S&P 500. They appear to be moving in different directions. It is still too early to say whether PFFA would actually outperform the broad market in terms of total performance for the rest of 2014. However, I definitely believe that these “value” sectors will continue to perform well for the foreseeable future.

I currently have a small position in PFFA in my income portfolio and plan to buy on the dip and accumulate more shares for the attractive 9% dividend and promising anticipation of good total returns in 2024.

Risks and warnings

In general, preferred stocks carry more risk than bonds, although they are safer than common stocks. Compared to investing in bonds, preferred stocks have a shorter tenure than bondholders. In case of liquidation due to bankruptcy of the company, the preferred shareholders are paid after the bondholders. So, preferred stock ETFs could be more affected by company bankruptcy once it happens.

Infrastructure companies are typically capital intensive and tend to be rate sensitive. There is a risk that inflation will remain at the current high level. This may affect the rate cut and negatively impact the performance of the ETF.

Investors should also review the risk statement contained in the ETF’s prospectus, including leverage risk, non-diversification risk, etc., before making an investment decision.

Closing thought

Preferred stock ETFs are income alternatives for investors looking for a high yield such as 9%. PFFA has an infrastructure-focused portfolio that spans multiple sectors, which are considered to be value asset classes. The portfolio should perform well during market swings. Constituent companies are experiencing a significant recovery in growth after being hit hard by the rapid rate hike. The much-anticipated rate cut will be a tailwind for continued growth. I rate PFFA as a buy and recommend it to those looking for income.