How You Can Access Everything From Tax-Free Bonds To Preferred Shares Using ETFs

As the stock market has fallen, many investors have turned to investment vehicles that can produce income. In this interview with DailyMarkets.com, Ed McRedmond, Senior Vice President at Invesco Powershares, gives investors some ideas about how they can access everything from preferred stock offerings to tax-free yield producing bonds using Exchange Traded Funds (ETFs).

Can you tell us some of the different ways investors can access income producing assets using the PowerShares ETFs?

The PowerShares ETF line-up includes a number of options for investors seeking income.  Some of our more popular income-oriented ETFs recently have included the PowerShares Financial Preferred (PGF) and PowerShares Preferred Portfolio (PGX) which offer very attractive yields and in the case of PGF, an alternative way for investors to get exposure to the financial sector versus a fund focused on financial common stocks.

Our tax-free municipal ETFs include Insured National, CA and NY funds and a VRDO Tax-Free Weekly ETF, each of which are AMT-free portfolios and are seeing greater interest as talk of higher tax rates emerge from the new administration.  Investors are also taking a look at high-yield bonds as their yields remain near historic levels relative to treasuries and an ETF like the PowerShares High Yield Corporate Bond (PHB) provides exposure to a basket of high-yield bonds.  And finally, our PowerShares Dividend Achievers ETFs follow various Mergent Dividend Achievers indexes consisting of stocks that have a long-term record of consecutive dividend increases, like PFM.

How does income from the various PowerShares ETFs get distributed to investors?

The PowerShares ETFs will typically distribute their net investment income on a monthly or quarterly basis.  The fixed-income ETFs focused on municipals, treasuries, preferreds, high yield bonds and emerging market debt will pay monthly distributions while those focused on dividend-paying equities like our Dividend Achievers ETFs typically pay quarterly dividends, except PEY which pays monthly.

Let’s take a look at the PowerShares VRDO Tax Free Weekly Portfolio (PVI). Can you give us a brief description of it?

The PowerShares VRDO Tax-Free Weekly Portfolio is based on the Thomson Municipal Market Data VRDO Index. This Index is designed to track the performance of a pool of tax-exempt Variable Rate Demand Obligations (VRDOs) issued by municipalities in the U.S. on which the yields generally reset on a weekly basis. VRDOs are high-quality, floating-rate bonds that provide investors with tax-exempt income.

Since the interest for the bonds held by the PVI is reset weekly, does it mean investors can get in now when rates are low and that the rates could potentially adjusted upward in the future?

That’s correct.  If short-term tax-free interest rates rise, one would expect to see the dividends paid by PVI also increase.  We are seeing investors using PVI in two ways; first, as an alternative for investors seeking higher-yielding short-term investments and secondly, in conjunction with longer maturity investments as a way to reduce or target the duration for their fixed-income portfolio.

Explain a bit more about the tax exempt status of the VRDO securities in this ETF. From the prospectus, it seems that some assets may be tax exempt now but may not be in the future. How can an investor keep track of this so that they report correctly?

PVI currently distributes 100% federal tax-free income.  The disclosure language in the prospectus is standard disclosure language that is meant to cover a wide range of possible scenarios.  If that was ever to occur, the index methodology would require that issue be removed from the index which would then be reflected in the ETF’s holdings.  Owners of PVI will receive 1099’s that will classify their dividends received for tax purposes.

Tell us about the PowerShares Preferred Portfolio (PGX) and the PowerShares Financial Preferred Portfolio (PGF).

We’ve seen investor interest in preferred securities spike in recent months as the US government has used preferred securities as its primary vehicle for investing in a number of companies, mainly in the financial sector.  The PowerShares Financial Preferred Portfolio (PGF) is based on the Wachovia Hybrid & Preferred Securities Financial Index.

The Index tracks the performance of U.S. listed preferred stocks issued in the US market by financial institutions and recently included approximately 39 securities.  The recent 30-day SEC yield was approximately 17.2%.

The PowerShares Preferred Portfolio (PGX) is based on the Merrill Lynch Fixed Rate Preferred Securities Index, which is designed to replicate the total return of a group of investment-grade preferred securities and recently included approximately 77 securities. The recent 30-day SEC yield was approximately 11.8%.

In the current financial crisis where counter-party and default risk has become very real, how does the risk of investing in preferred shares compare to buying the common stocks of the same companies?

Preferred securities rank higher in the capital structure of a company than common stock and therefore would be paid ahead of common shareholders in the event of a bankruptcy.  However, it’s important to remember that they still come after a number of other creditors such as loan and bondholders.

Ed McRedmond is the senior vice president of Portfolio Strategies for PowerShares Capital Management LLC. At Invesco PowerShares, Mr. McRedmond works on increasing the awareness and use of PowerShares ETFs within the various distribution channels, working with ETF analysts, due diligence groups and portfolio managers that construct ETF models and portfolios, along with sales and marketing personnel.

He joined PowerShares in 2005 after 17 years at A.G. Edwards, where he was Associate Vice President and a member of the Allocation Advisors Investment Committee. While at A.G. Edwards, Mr. McRedmond also served as senior analyst covering exchange-traded funds and closed-end funds and was a key part of the team that launched and managed A.G. Edwards’ discretionary ETF model portfolios.

Mr. McRedmond was also a member of the St. Louis Financial Analysts Society. Prior to joining A.G. Edwards, Mr. McRedmond was a founding member and supervisor of Charles Schwab’s Active Trader group.

Mr. McRedmond has been quoted in numerous publications such as Barron’s, The Wall Street Journal, Business Week, Forbes, The NY Times and Kiplinger’s Personal Finance Magazine. In 2008, he received the award for Contribution to the ETF Sector at the Capital Link Closed-End Funds and Global ETF Awards Conference and was also an Honorable Mention recipient at the 2007 Capital Link Closed-End Funds and Global ETF Awards Conference for Contribution to the ETF Sector.

Mr. McRedmond is a graduate of Quincy University with a B.S. degree in Economics & Finance and was a two-time winner of the school’s annual investment challenge for the top performing student selected portfolio.

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