In times of record low interest rates, a ten-year bond that yields less then 2% for the first time in history, a savings rates at or below 1%, a Federal Reserve that has pledged to keep rates low until mid-2013 and a sinking a stock market, one can be forgiven for wondering where to invest.
While there is clearly no right answer for everyone, there is a small, underfollowed class of securities that offers good yield and (I'll argue) limited downside. Many here on SA are familiar with preferred stocks and their various permutations (i.e. cumulative, non-cumulative, perpetual, floating rate, etc.) as well as the fact that many preferreds happen to be issued by financial institutions and real estate related companies, two areas that are fraught with risk. What if there were preferred issues with good dividend protection, limited capital risk and well-known firms behind them? Since I'm writing this article, the answer is obviously that they exist.
I am talking about preferreds issued by closed-end funds. It is common knowledge that some-closed end funds boost their returns by taking on leverage. Most of this leverage takes on the form of auction rate securities, or very short term paper and is utilized most often by fixed-income funds. The rates on this paper are very low providing a low, albeit fluctuating, cost of capital for these funds. There are a few closed-end equity funds, however, that utilize a different method of leverage, namely preferred stock.
These issues are callable usually once per year and do not often trade below par. Therein lies the principal risk if you purchase above par and they are called. If you are patient you can usually buy them at the low end of their respective ranges. Furthermore, they are all cumulative preferreds. Finally, the underlying fund must maintain at least a 2:1 ratio of common equity to preferred. If the common were to crater (along with, say, a rapidly falling stock market), the fund would have no choice but to purchase preferred to bring the ratio back in line, as required by regulations.
There are nine preferreds (yes, just nine) that are outstanding on closed-end equity funds. While I have been unable to locate a public list online, I will mention them all here, with the symbols for the underlying funds :
- Gabelli Dividend & Income Trust Preferred A: 5.875% coupon (NYSE:GDV)
- Gabelli Dividend & Income Trust Preferred D: 6.000% coupon (GDV)
- Gabelli Equity Trust Preferred D: 5.875% coupon (NYSE:GAB)
- Gabelli Equity Trust Preferred F: 6.200% coupon (GAB)
- Gabelli Global Gold, Natural Res & Income Trust: 6.625% coupon (NYSEMKT:GGN)
- General American Investors Preferred B: 5.950% coupon (NYSE:GAM)
- Royce Micro-Cap Trust Preferred A: 6.000% coupon (NYSE:RMT)
- Royce Value Trust Inc. Preferred B: 5.900% coupon (RBT)
- Tortoise Energy Infrastructure Preferred A: 6.250% coupon (NYSE:TYG)
You should perform your own due diligence to determine whether this type of security has a place in your portfolio.