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Weekly Review Of Preferred Stock CEFs: Several Closed-End Funds Reached New Heights

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Includes: FFC, FPF, HPF
by: Arbitrage Trader
Arbitrage Trader
Arbitrage, debt, bonds, short-term horizon
Summary

The leading benchmark of the sector looks stable without any great volatility or trading volume.

The bond ETF is stable as well.

Almost all of the closed-end funds trade at high premiums.

Several closed-end funds announced their regular distributions.

Introduction

It seems that the past week was calm for the sector and the instruments traded quite stable. Many of the Z-scores that we discussed in our last article are much higher today and even positive. The average Z-score is higher today, the average discount as well. The leading benchmarks traded quite stable during the short week. There are a couple of overvalued closed-end funds which deserve our attention as well.

The News

Source: Yahoo.finance.com

The Benchmark

During the past week, the leading benchmark of the preferred stock sector (PFF) finished negative, closing the last trading session with a loss of only $0.03 per share. The trading volume of the ETF was below the average one. PFF started the week modest but quite promising with higher opening at $37.23 per share, but came the 'Black Friday' and erased all of its gains during the short week.

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). The past week was calm with very low trading volume. However, the bond ETF finished positive in the end of the week. On a weekly basis, TLT rose with $0.12 per share closing the week at a price of $140.42 per share.

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

Below we can see where is the 10-Year Treasury rates:

Source: cnbc.com - 10 Year Treasuries

1. Sorted By Z-Score

Source: cefconnect.com

From the table above we can see the statistical evaluation of the different closed-end funds in the sector. As we can easily see, we do not have any negative results in the chart today. The lowest result that we can find is -1.22 points.

The undisputed leader in the chart today is the Flaherty & Crumrine Preferred Income Fund (PFD). The closed-end fund is statistically overvalued. It has a 2.07 score. Another thing we should notice is the high premium at which the CEF is trading - 13.76% which is the highest premium in the sector as well.

The week was positive for the fund with quite low trading volume as we can see on the chart beneath:Source: barchart.com - PFD Daily Chart (6 months)

The silver medal today goes to the Flaherty & Crumrine Preferred Securities Income Fund (FFC) which has a result of 1.84 points. FFC has a high NAV/price spread as well. These two criteria combined together give us an edge to consider the fund as a probable "Sell" candidate. On Friday the preferred closed-end fund reached a new 52-week high:

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

The trading volume during the past week was below the average for the fund as we can easily see.

The only CEF with a Z-score below -1.00 is the John Hancock Preferred Income Fund II (HPF). HPF is the only fund in the chart which could be considered as undervalued. Of course, this is only from a statistical perspective that we are speaking. Despite that on an average level HPF's premium is quite low, it is still a premium, so I would not rush to consider it as a "Buy" opportunity. Here we only have a statistical edge.

2. Baseline Expense

Source: cefconnect.com

The most "expensive" preferred closed-end fund is the John Hancock Premium Dividend Fund (PDT). 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 change 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. And, as we already mentioned, the performance of the sector lets us take a look at the most generous CEFs in the group.

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. 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 easily see from the table, the John Hancock Premium Dividend Fund is not only the most expensive fund, but the most generous as well. The average return in the preferred sector is 7.65%. PDT has a return over 9.30%, which is way above the average result, as we can see.

4. Discount/Premium

Source: cefconnect.com

As a whole, the funds in the sector trade at high premiums. We have had some negative results as well.

At the top of the chart once again we find the Flaherty & Crumrine Preferred Income Fund. As we already mentioned the CEF trades at 13.76% premium:

Source: cefconnect.com

As investors we all know that numbers do not lie. As we see the numbers show us that PFD is hovering around its 52-week high which is 14.11%. Below we can see how wide is the spread at the moment:

Source: cefconnect.com

If things get ugly in the preferred world I would definitely go "Short" in PFD. We have quite wide spread at the moment and statistically I like what I see as well.

At the bottom of the chart we find the First Trust Intermediate Duration Preferred & Income Fund (FPF) which has the lowest NAV/price spread in the group. FPF is currently trading at a -1.11% discount:

Source: cefconnect.com

As we can see from the image above, FPF's price is trading quite high compared to its net asset value. The average level of the CEF's discount is -4.23%:

Source: cefconnect.com

The chart clearly shows that the fund is at its highest point at the moment since an year, maybe even more. Compared to its peer group FPF is trading quite low:Source: cefdata.com

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.

Conclusion

The preferred stock sector does not provide us with significant arbitrage opportunities at present. Most of the closed-end funds are trading at premiums, and it is difficult to find so many potential "Buy" opportunities. On the other hand, there are still interesting funds which provide us with an attractive valuation based on the discount, and we can review them as potential "Short" candidates if their Z-scores are not too high.

Note: This article was originally published on December 1, 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.