As an early middle-aged investor, I've been slowing pivoting my portfolio more towards income-generating investments. One of the reasons for doing so is to slowly build up an income stream that could help sustain a semi-retired or retired lifestyle in the years to come.

One of my favorite income generating assets are Nasdaq Covered Call Funds, and I recently wrote specifically about the possibility of generating a ~15% yield from the Global X Nasdaq 100 Covered Call ETF (QYLD). That QYLD / Short Futures combo represents, by far, the highest yield in my portfolio. I'm more risk-averse than in the past, and generally stay away from high-yielding stocks, bonds, or investment funds.

My Preferred Share Exposure

I currently complement the above income holding with a variety of preferred share ETFs. You might be asking what the reasoning is behind investing in multiple different preferred share funds, and I agree it's possibly overkill here. But there's an explanation why I have a few of them. My biggest preferred share ETF holding is the Invesco Variable Rate Preferred ETF (VRP). I initially invested in VRP, as well as the BMO Laddered Preferred Share Index ETF (ZPR:CA) to minimize my exposure to rising interest rates. Preferred Stock, of course, trades much the same as bonds do - rising rates reduces the relative economic value of the fixed income streams. Both VRP and ZPR, with their resets and laddered structure respectively, were chosen to minimize that interest rate risk. I'm also more diversified here, given that ZPR is invested in the preferred stock of Canadian firms.

I added another preferred share ETF along the way: the VanEck Preferred Securities ex Financials ETF (PFXF). For those investors who haven't looked at the holdings for preferred share funds, you may not realize that the majority are in the Financials sector. This gave me the creeps when the liquidity problems/bank run issues emerged at Silicon Valley Bank in Q1 2023. I decided I needed to reduce my exposure to Financials. In fact, I encourage all investors holding income ETFs/mutual funds to review the sector allocations they are exposed to.

With inflation seemingly under better control now, and interest rate increases further in the rearview mirror, I'm investigating whether I'm in the right preferred share ETFs going forward. Today, I'm reviewing the Virtus InfraCap U.S. Preferred Stock ETF (NYSEARCA:PFFA).

PFFA's unique traits

The first thing investors may notice about PFFA is that it's a leveraged preferred share ETF. This means that the fund not only invests its AUM in preferred shares, but also borrows money to increase its preferred share exposure.

The above diagram suggests that the PFFA fund managers have currently borrowed an amount equal to ~28% of the NAV to invest in additional preferred share issues, while maintaining a liquidity buffer of about 5%. Per the prospectus, the ETF is allowed to borrow up to 33.33% of its asset base.

I was surprised to learn that PFFA is able to take short positions up to 20% of its assets, and the managers can also purchase or write options. In reviewing the ETF's recent holdings, short positions and/or options positions weren't obvious to me.

In looking at the ETF holdings, however, I noticed a distinct difference in the type of preferred share issuers as compared to the preferred share funds I already own.

I hadn't expected to see companies I've never heard of among the top holdings of PFFA - FTAI Aviation and DigitalBridge Group, for example. Nothing against these companies, whose business and management might be outstanding, but I just wouldn't be confident taking any meaningful position in PFFA without researching some of these unknown (to me) top holdings more closely. I remind myself that I'm not looking for capital gains here, but a steady and secure stream of preferred dividend payments.

Performance

The below chart illustrates PFFA's performance against the existing Preferred Share ETFs that I own.

1-year Total Return

3-year Total Return

(Note: ZPR is a Canadian Dollar denominated ETF)

PFFA has performed quite well on a relative basis over both 1-year an 3-year periods. I'm not surprised, however, to see PFFA at the bottom of the pack at year-end 2022 when stock markets were wavering. Again, this fund has less exposure to blue-chip companies.

Expenses

Preferred Share ETF	Expense Ratio (per Morningstar)
PFFA	2.52%
VRP	0.50%
PFF	0.46%
PFXF	0.41%
ZPR.CA	0.50%

I noticed this in researching PFFA's prospectus: the fund has a management fee of 0.8%, but is also tacking on an additional 1.72% of expenses, possibly 12b-1 fees, and those linked to conducting leverage operations.

It's terribly difficult to justify such an elevated expense rate compared to others. The AUM of the ETF is similar to the others reviewed above, yet the fees are 5x or more those charged by these competing ETFs. Keep in mind that the performance numbers listed previously are net of fees, so the managers of PFFA have done a good job of delivering performance that mitigates the high ETF expenses.

Summary And Conclusion

It's interesting that PFFA crossed my desk as I was reviewing possible alternatives for my existing preferred share ETF holdings as the interest rate spectrum changes.

I'll be continuing my search for alternative options for the interest-rate protected preferred share ETFs in my portfolio. Especially if there's a downward market on the horizon, I'd be nervous about holding preferreds issued by some of the unfamiliar companies held by PFFA. My hesitation on PFFA is furthered by the much higher expenses incurred by this ETF. Some of those fees may be linked to the leverage activities undertaken by the fund, but I don't see the appeal to exposing my portfolio to this ETF.