Weekly Review: Preferred Stock CEFs

Summary

• Review of how preferred funds ended last week.
• Comparison of the Closed-End Funds in the group.
• Recap of news related to the sector.

Introduction

Over the last few months, most of you have noticed our increased activity in Closed-End Funds, as the inflow of volatility finally shook them up and created various arbitrage, and directional, opportunities for active traders such as us.

Now that these products have our attention, we are continuously monitoring most funds by sector and will reinstate our Weekly Review, publishing a recap of the groups of interest.

The News

_{Source: Author's software}

There were no major news about this group of the closed-end funds which could have had an impact on their performance.

The Sector

^{Source: Barchart.com - PFF Daily Chart}

S&P US Preferred Stock Ishares (NYSEARCA:PFF) started the first day of the week in negative territory and this set the tone for the rest of it, in spite of the signs of life it showed mid-week. Many products from the preferred stock universe followed on the way down.

This move was not triggered by weakness in the 20 Year Bond Ishares (NYSEARCA:TLT), as you can observe in the chart below, therefore we can conclude that it represents a narrowing of risk premium for preferred stocks. Or it could have simply been a technical correction.

^{Source: Barchart.com - TLT Daily Chart}

The upward move in TLT is most likely related to the instability in the equity market, but the correlation between the two has been ‘on’ and ‘off’ over the last two months, so it is hard to tell.

1. Sorted by Z-Score:

_{Source: CEFConnect.com}

Given the benchmark’s performance for the week, it is no surprise to see that Discounts have widened a bit and respectively this has driven some funds’ Z-scores lower relative to our previous review.

There have been shifts and there is a new leader in the group - Flah & Crum Dynamic Pref & Inc fund (DFP) – whose Z-score has dropped from -1.50 to -2.10, which makes it statistically undervalued. Another one to take note of is the Flah & Crum Preferred Income fund (PFD) with a score of -2.00.

Statistically we do not have an overvalued fund as the highest score in the table above is 0.70. I do not think that we could find a potential ''Sell'' candidate here. Since none of the CEFs is overvalued, it would be hard to construct a meaningful pair trade inside the group.

2. Baseline Expense:

_{Source: CEFConnect.com}

What we concluded is that the typical Preferred Stock closed-end fund has an expense ratio in the range of 0.66% to 1.45%. Personally for me a management fee over 1% is quite high. While building a Fixed Income portfolio does require some knowledge, it definitely is not a task that would justify anything much higher than 1%.

3. 5-year Return on NAV:

_{Source: CEFConnect.com}

There are no major changes on the chart - everything is the same from last week. The sector has delivered delightful returns to the fixed income investors over this time frame. In truth - and as stated on must fund sponsor websites - past returns are no guarantee of future performance. And this is truer than ever, because we have yet to see the managers earn their management fee in a rising interest rate environment.

4. Discount/Premium:

_{Source: CEFConnect.com}

What we concluded here is that the fund with the most highest discount of all is the Flaherty & Crumrine Total Return fund (FLC). Judging purely by this metric, this is the most undervalued fund currently. I also want to stop your focus on its z-score, where we can see that the fund is also statistically undervalued whith a negative score of -1.90. But there is much more to it than Discount as an absolute value. As an observation, most of the CEFs trade lower than their Net Asset Value.

Once again we do have on the chart only to funds that trade above their net asset value and they are the same funds as previous week - Nuveen Pref and Inc 2022 Term (JPT) and JH Premium Dividend Fund (PDT).

5. CEFs' Distribution Rate:

_{Source: CEFConnect.com}

I would really want to leave this blank, because distribution rate has no real value. It makes absolutely no sense to look at this metric. It is not how much one distributes, but how much one earns that truly matters. Return on NAV is the real metric to monitor.

6. The Effective Leverage % of the CEFs:

_{Source: CEFConnect.com}

Here we can see that most of the funds are similar in leveraging their returns.

7. Trade Proposal:

First and foremost, we do not find any of these funds to be a bargain from a fundamental point of view. This does not mean we cannot find a trade.

The fund that grabbed our attention is the Flaherty & Crumrine Total Return Fund (NYSE: FLC):

Source: CEFConnect.com - FLC

As we see here on this chart, the NAV has not moved a lot while the price has dropped sharply. The above screenshot shows the movement of the NAV/Price on a 1-year time frame. Now let us look at what the 5-year will show:

Source: CEFConnect.com - FLC

As we go 5 years back, the chart shows us that the recent deviation is not that unusual and so far, the fund has always mean reverted to its Net Asset Value.

Another two highly precious signs for us to see that the fund might be a bargain is the Z-score and return on its net asset value for the past five years. It is statistically undervalued with a score of -1.90 which as we see is also confirmed by its discount trade price. 8.43% is the return on NAV for the last five years that this fund provides to its fixed income investors. Basically relying on those indicators we could say that this is a good fund for a "Long" position. As we see it has all the good signs that we look for when we want to trade CEFs. I would also like to remind you that before you jump in any kind of trade, it is required to do a more deeper research.

Conclusion

Depending on market conditions one could argue that the group of funds presented here is undervalued as a whole, some of them being better than others respectively.

Before jumping gun and attempting to be 'the early bird' in any Preferred Stock CEF, we want to see further strength by the related indices, or a upswing in the NAV.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in FLC over the next 72 hours. 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.