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.
Source: Author's Software
Over the past week, there was no news that could affect the sector's performance.
After the leading benchmark of the preferred stock sector (PFF) reached its high point of $38.80 per share and it fell rapidly after that, today we find it more than a point lower. The week was calm for the sector if we do not include the sell-off in the last session. Until Friday, the preferred ETF was trading in a range of less than $0.10. However, by the last closing bell for the week, the fund finished negative at a price of $37.60 per share. Which on a weekly basis is a drop of $0.14 (-0.37%).
Source: Barchart.com - PFF Daily Chart (6 month)
The 20+ Year Treasury Bond ETF (TLT) performed negatively over the past week as well. On Monday, the ETF opened with a gap, as you can notice on the chart beneath. The fund closed at its low point for the day at a price of $119.27 per share. TLT has also entered in a sideways range. However, the fund finished the week lower compared to the opening price on Monday.
Source: Barchart.com - TLT Daily Chart (6 month)
The behavior of the fund we can justify with the rising 10-year treasury interest rate, which on Monday was headed towards the terrifying level of 3.00%.
All that said, let's proceed with the CEFs invested in these products and see if we can find something worth our attention.
1. Sorted by Z-Score:
We use the Z-score to find statistically undervalued or overpriced funds in the sector. If the value of Z-score is negative, it signals a "Buy" opportunity. Reversely, if you are looking for a "Sell" candidate, you should be interested in a positive Z-score value.
The leader from last week is still on top of the table with its high Z-score of 2.30. The Cohen & Steers Select Preferred & Income Fund (PSF) has reached a new high in its performance. The fund hit a price of almost $28.00 per share and if not for the sell-off on Friday, it might have continued adding value. On a weekly basis, it has also added 0.50 points to its Z-score and in addition to that we have the fund trading at a high premium of over 6.00%. In my opinion, this could be a "Short" candidate for our portfolio because we have met all the requirements that we seek for this kind of trade.
Another probable "Sell" candidate that caught my eye is the Flaherty & Crumrine Preferred Income Opportunities Fund (PFO). The fund has a positive Z-score of 2.00 and a current premium of 3.82%. I just want to remind you that this fund had a negative Z-score only week ago.
At the bottom again we find the Nuveen brothers. The dividend cut that they experienced lately smashed them to quite depressed levels. The Nuveen Preferred and Income Term Fund (JPT) even hit an all-time low on Friday. The fund has a Z-score of -2.30, which from a statistical perspective makes it a "Buy" candidate, especially when we add the heavy discount that it is trading at currently.
Below we can see that the CEF is headed towards its 52-week low of -5.40% discount.
2. Baseline Expense:
It is important to know the expense of the funds that we invest in. Here we can see how much the funds charge investors for managing their portfolio. The average fee in the sector that the managers are going to charge us is about 1.20%, which for me is not quite justified, but it is acceptable.
3. 5-Year Return On NAV:
The aim of the above ranking is to show us the Preferred funds with the higher yields based on the net asset value. The combination of the return with the other metrics that we have is a foundation of our research for potential "Long" candidates.
As we can see, the Flaherty & Crumrine Dynamic Preferred & Income Fund (DFP) is the best CEF of all in the group. Taking that, and the discount that it is trading currently at, makes the fund not a bad "Buy" candidate.
Here again, my "Short" candidates will be the same. As we can easily notice, PFO and PSF are trading at the highest premiums of all in the group. PSF is hovering around its 52-week high premium of 7.35%. Below we can see how the numbers look on the 1-year Price/NAV chart:
As for the "Long" candidates, I can say that I am eager to see the Nuveen family back to the heights. As we see on the table, they are the ones with the most widened discounts of all. And as we already discussed earlier, they are undervalued from a statistical perspective as well.
5. Effective Leverage:
All of the closed-end funds in the sector are leveraged. The average percent of effective leverage in the sector is about 32%. We should keep that in mind when we do our homework on preferred CEFs.
6. Distribution Rate:
The table shows the funds with the highest distribution rate on price. Additionally, I have plotted here the distribution rate based on the net asset value. Most of the market participants find the second metric to be more important.
Week after week, the sector becomes more and more volatile and there are more trading opportunities, including arbitrages, etc. All in all the sector is still undervalued but I believe that soon it will show its full potential and the fixed-income investor will be more than delighted.
Note: This article was originally published for our subscribers on 7/29/2018, 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.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in JPT, FPF 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.