Weekly Review: Preferred Stock CEFs
- Review of how preferred funds finished the week.
- Comparison of closed-end funds in the group.
- Recap of news related to them, if there are any.
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.
There was no news relevant to the constituents of this group over the last week.
The leading benchmark for the sector - iShares U.S. Preferred Stock (PFF) - has seen better days:
Source: Barchart.com - PFF Daily Chart (6 months)
This week was colored in red for the PFF. We can all see the red bars from Monday and Tuesday. On the last day of the trading session, the index made an attempt to break through to positive territory but without success. This can probably be attributed to the slight bounce observed below in the 20+ year Treasuries:
Source: Barchart.com - TLT Daily Chart (6 months)
It is above our pay grade to determine where the TLT is headed and whether this small upswing is going to last.
Anyway, let us proceed with the CEFs invested in these products and see if we can find something worth our attention.
1. Sorted by Z-Score:
Above we can monitor the statistical 'evaluation' of the different preferred funds. At first sight, we can notice that there are a lot of undervalued funds from a statistical perspective.
First Trust Intermediate Duration Preferred & Income Fund (FPF) has the lead this week with a negative Z-Score of -2.10. We can also notice that it is trading at a big discount. These two criteria combined together give us the first ''Buy'' signals that we are looking for.
Another potential ''Buy" I can find in the face of Cohen & Steers Select Preferred and Income (PSF). Also with a negative z-score of -2.10 it is statistically undervalued and at present it is trading below its NAV. The only thing we should consider here is its relative low average daily volume:
However, this should not rush you in making any kind of trade decisions because we are only scratching the surface here.
Today the numbers show us that we do not have any overvalued funds, at least from a statistical point of view. I also believe that we cannot find a potential “Sell” candidate here either. Therefore, it would be hard to construct a meaningful pair trade inside the group.
All that said, let us continue with the examination with the other criteria of our preferred funds.
2. Baseline Expense:
What we concluded is that the typical Preferred Stock closed-end fund has an expense ratio in the range of 0.86% to 1.45%. I will not stop saying that these management fees are quite high for me. While building a Fixed Income portfolio does require some knowledge, it definitely is not a task that would justify anything much higher than 1%.
Let us proceed with the quest of finding a bargain.
3. 5-year Return on NAV:
Stable, juicy and delightful are the first words that pop up in my head when I see the returns over this time frame. The numbers are indeed decent, yet no guarantee of future performance.
Past performance should not be the sole reason to establish a position – a deeper look is needed.
There are almost no changes in the ranking, nor in the numbers, this week.
The undisputed leader several weeks in a row is the Flaherty & Crumrine Total Return fund (FLC). It is trading far below its net asset value and as we can monitor on the right, it is also statistically undervalued. When we add the juicy return that it gives its fixed income investors we could probably say that this fund might be quite the bargain.
Source: CEFConnect.com - Flaherty & Crumrine Total Return fund
Here on the five-year chart we can see how close the NAV and the price are moving most of the time. We can also see the current movement and the widened spread between the net asset value and the actual price. Once this spread starts narrowing this fund will be quite a "Buy."
Without a change, the most overpriced fund is the JH Premium Dividend Fund (PDT). It has not moved from the top in weeks now. This is the only fund in the group that is trading above its net asset value, but I think I would not consider it as a perfect ''Sell'' just yet. If we take a closer look we can see that it is not statistically overvalued and on top of that it has given one of the best returns over the time. So, I do not think that only because it is trading above its NAV makes it a "Short" position trade.
6. Effective Leverage:
When we look at the effective leverage percentage, we can understand these high return results that the funds provide us with. This indicator is also quite important when we do our homework on the closed-end funds. Basically what we have concluded is that the leverage of the different funds is between 20% and 35%.
The sector is still trading at relatively depressed levels due to a plethora of reasons which we would probably need several articles to discuss. One could argue that the group as a whole is undervalued, but this kind of opinions can be very expensive.
Before jumping the gun and attempting to be 'the early bird' in any Preferred Stock CEF, we want to see further strength by the related indices, or an upswing in the NAV.
Note: This article was originally published for our subscribers on 4/29/2018 and some figures and charts may not be entirely up to date.
Trade With Beta
At 'Trade With Beta' we also pay close attention to closed-end funds and are always keeping an eye on them for directional and arbitrage opportunities created by market price deviations. As you can guess, timing is crucial in these kinds of trades, therefore you are welcome to join us for early access and the discussions accompanying this kind of trades.
This article was written by
Day trader whose strategy is based on arbitrages in preferred stocks and closed-end funds. I have been trading the markets since I started my education in Finance. My professional trading career started right before the big financial crisis of 2008-2009 and I clearly understand what are the risks the average investor faces. Being a very competitive trader I have always worked hard on improving my research and knowledge. All my bets are heavily leveraged(up to 25 times) so there is very little room for mistakes. Through the years my approach has been constantly changing. I started as a pure day trader. Later I added pair trades. At the moment most of my profits come from leveraging my fixed income picks. I find myself somewhere in between a trader and an investor. I am always invested in the markets but constantly replace my normally valued constituents with undervalued ones. This approach is similar to rebalancing your portfolio and I just do this any time there is some better value in the markets. I separate my trading results from my trading/investment results. I target 40% ROE on my investment account and since inception in 2015, I am very close to this target.
My main activity is running a group of traders. Currently, I have around 40 traders on my team. We share our research and make sure not to miss anything. If there is something going on in the markets it is impossible not to participate somehow. Some of my traders are involved in writing the articles in SA. As such Ilia Iliev is writing all fixed-income IPO articles. This is part of their development as successful traders.
My thoughts about the market in general:
*If it is on the exchange it is overvalued and our job is to find the least overvalued.
*Never trust gurus - they are clueless.
*Work hard - this is the only way to convince yourself you deserve success.
*If you take the risk it is you who has to do the research.
*High yield is always too expensive.
We are running a service here on SA. It is a great community with very knowledgable people inside. Even though we are not in the spotlight as often as we would like to our articles' results are among the strongest on SA. You can always contact me to share some of our articles and best picks so far.
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.
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