This Closed-End Fund Offers Exposure To Fixed-To-Floating Rate Preferred Securities

| About: First Trust (FPF)


Fixed-to-float preferreds are an alternative to fixed-coupon issues.

Fixed-to-float issues performed Well during the taper tantrum.

First Trust's FPF is an option to consider for exposure to this market.


The word on everyone's mind is "income." Low interest rates have reduced the cash flow bonds can offer and raised the valuation of many dividend-paying equities. Preferred stocks offer higher income but were not an area of the market many paid attention to until recently.

Preferreds come in two main flavors:

  1. Fixed coupon preferred stocks have the same coupon throughout the life of the issue. They offer high income yet tend to perform poorly during periods of rising interest rates.
  2. Fixed-to-floating rate preferred stocks have a variable rate coupon and offer an alternative to the traditional, fixed-coupon alternative. They may be an answer to those looking for both high income and rising interest rate protection.

I will discuss why the First Trust Intermediate Duration Preferred & Income Fund (NYSE:FPF) may be a good option for those looking to embrace this area of the preferred market.

What is a Fixed-to-Float Preferred?

A fixed-to-float preferred security offers a fixed coupon for a certain period of time. After this fixed coupon period, they reset to a fixed amount over a predetermined interest rate benchmark (most use three-month LIBOR).

I pulled the prospectus of two issues included in FPF to give you an example of this.

The first example is the Citigroup Series K issue:

(Source: EDGAR)

The second example is the Valley National Bank Series A issue:

(Source: EDGAR)

Rising Rate Protection and Performance

Once the fixed period is over, the floating portion of the coupon will be the three-month LIBOR rate. Three-month LIBOR has a history of tracking the Federal funds rate rather closely:

(Source: FRED)

You will have a security that offers a rising coupon if three-month LIBOR keeps rising. However, if three-month LIBOR stalls out, you can actually have a coupon less than the fixed period.

Cohen & Steers did research into the performance of fixed-to-float preferreds during the year of the taper tantrum and came up with the following result:

(Source: Cohen & Steers)

(Note that exchange-traded preferreds tend to be fixed-coupon while over-the-counter preferreds tend to be fixed-to-float.)

We can see that see that fixed-to-float issues generated a higher return than their fixed coupon counterparts during this period of rising long-term rates.

FPF Holdings and Characteristics

FPF was the first closed end fund I bought specifically because of its large exposure to fixed-to-float issues.

The fund currently has over 75% of its assets in floating rate or fixed-to-float issues.

(Source: First Trust)

It maintains greater than 50% of its assets in investment grade securities and almost half are issued outside of the USA:

(Source: First Trust)

The fund is dominated by the banking and insurance industries:

(Source: First Trust)

Many of its top holdings are not household names in the US. This is different than other preferred closed-end funds, which will have more recognizable names in the top 10 list.

(Source: First Trust)

FPF Discount and Income

Many CEF buyers pay close attention to the source of a fund's distribution.

Reading the fund's 19a-1 Notice shows 100% of its distributions are net investment income:

(Source: First Trust)

FPF yields 8.29% as of this writing and has a discount of 1.7%.

Pulling up a chart at CEFConnect shows this fund spends a lot of time near double-digit discount territory:

(Source: CEFConnect)


FPF has been a long-time holding of mine. I purchased it when the discount to NAV (and yield) was higher than it is today. I was initially concerned over the lack of "name brand" issuers in the top 10 but some research showed they're actually well run firms.

Its high exposure to fixed-to-float issues means the fund will perform better than its fixed-coupon counterparts based on data from 2013. However, the yield on the fund is high enough that it will most likely attract retail investors even if the 10 YR hits 2% or 3%. There simply isn't enough yield in bonds to make FPF unattractive even if rates rise from here.

Would I establish a new position today? No. The current discount is very narrow, the yield is on the lower end of its range, and the price is closing in on its post-IPO highs.

I would keep it on the watch list for the future.

Disclosure: I am/we are long FPF.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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