Seeking Alpha

Weekly Review Of Preferred Stock CEFs: The Sector Starts Looking A Bit Overvalued

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Includes: HPF, PSF, TLT
by: Arbitrage Trader
Arbitrage Trader
Arbitrage, debt, bonds, short-term horizon
Summary

Review of how preferred funds finished the week.

Comparison of closed-end funds in the group.

Recap of news related to them, if any.

Introduction

Over the last year, 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: Yahoo Finance

Over the past week, there was no news that could affect the sector's performance.

The Benchmark

Another positive week for the leading benchmark of the preferred stock sector (PFF). The week was calm for the preferred stock index. The volume was a little bit over the average levels but without any great volatile. PFF closed the trading week at a price of $36.34 per share. On a weekly basis, the index added $0.05 per share to its value.

Source: barchart.com - PFF Daily Chart (6 months)

As you know, we follow the performance of the U.S. Treasury bonds - considering them a risk-free product - with maturities greater than 20 years: the iShares 20+ Year Treasury Bond ETF (TLT). Quite a week for TLT. On the first day of March, the ETF hit its support at $119 per share. Luckily, the fund bounced with the start of the new week, closing at a price of $121.57. On a weekly basis, the benchmark has added to its price of $2.91 per share.

Source: barchart.com - TLT Daily Chart (6 months)

1. Sorted by Z-Score

Source: Cefconnect.com

Lately, the preferred stock sector is statistically overvalued. Today, we continue to monitor the high Z-scores in our weekly review.

In the frames of this metric, the John Hancock Preferred Income Fund II (HPF) is the most overvalued CEF among all in the sector. The fund has a Z-score of 1.70 and trades at a high premium. These two metrics are green lights for a probable "Sell" candidate. On the last trading day of the week, HPF distributed its regular dividend of $0.14 per share. Currently, the CEF is pumped and close to its 52-week high:

Source: barchart.com - HPF Daily Chart (6 months)

The silver medalist in our table today is the Cohen & Steers Select Preferred and Income Fund (PSF) which has a Z-score of 1.50. PSF trades at quite a high premium as well. We will revise the fund's premium a little bit later. I would add PSF in my watch list as a potential "Short" candidate.

As we can easily see, there are still no closed-end funds which are statistically undervalued, hence, we cannot construct a pair trade here.

The average Z-score in the sector is 0.94.

2. Baseline Expense

Source: Cefconnect.com

From the above table, we could get information on how much the different funds charge us for managing our portfolio. As we can see, the average charge in percent is 1.20%. Anything over 1% is a little bit high for me, but 1.20% is still acceptable, especially when we keep in mind the delightful performance of the sector.

3. 5-Year Return On NAV

Source: Cefconnect.com

The aim of the above ranking is to show us the closed-end funds with higher yields based on the net asset value. Combination of the return with the other metrics that we have is a foundation of our research for potential "Long" candidates.

The average return in the sector is 7.91%.

4. Discount/Premium

Source: Cefconnect.com

The undisputed champion is still the John Hancock Premium Dividend Fund (PDT). Currently, the CEF is trading at an 8.17% premium:

Source: cefdata.com

The 52-week average premium for the fund is 7.38%.

As we already discussed, we spotted the Cohen & Steers Select Preferred and Income Fund as a potential "Sell" candidate. The high statistical evaluation is quite attractive but its high premium is the thing that grabs me more. Currently, PSF trades at a 7.67% premium. It is now hovering around its 52-week highs:

Source: Cefconnect.com

The chart translated in numbers:

Source: Cefconnect.com

It is not hard to see that the CEF has a net asset value below its average one but still, it trades more than 5% higher from its average levels. PSF's NAV change during the past week:

Source: Cefconnect.com

My second pick for the day will be the bronze medalist in this table - HPF. The closed-end fund trades at a 5.83% premium:

Source: Cefconnect.com

Looking pretty good for a "Short" candidate. If we look back historically, the preferred CEF has kept tight spread with its peers. The current spread that we witness is quite wide:

Source: cefdata.com

HPF compared to its peer group:

Source: cefdata.com

The average discount in the sector is -0.03%.

5. Effective Leverage

Source: Cefconnect.com

Leverage magnifies returns, both positively and negatively. And, we look at the effective leverage percentage, and 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 average leverage percent in the group is 31.65%.

6. Distribution Rate

Source: Cefconnect.com

Above, we saw what was the historical performance of the funds, but probably, most of you are interested in the current return which could be achieved, and that is the reason why I sorted the funds by the highest distribution rate.

The average yield on price for the sector is 7.35% and the average yield on net asset value is 7.35%.

Conclusion

It seems that the preferred stock sector is a little bit overvalued. We see that there are funds which have high Z-scores, and at the same time, there are no negative ones. Some of the CEFs are trading at wide discounts, but are they really so wide? If we take a closer look, we find out that actually, they are way higher than their average levels. On the other side, the NAVs are at relatively low levels.

Currently, I do not see a bargain in the sector, at least not on the "Long" side. We should be careful when entering long positions at these current levels.

Note: This article was originally published on March 10, 2019, and some figures and charts might not be entirely up to date.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.