We are writing a series of reviews for those fixed-income investors who want to stay away from the interest risk, despite the current expectations of lowering interest rates. Presenting all term preferred stocks and baby bonds with a stated maturity date in less than 10 years. These are usually issues with no more than 2-3M preferred stocks/notes and, in most cases, not rated by any of the big three rating agencies. With regards to the largest primary exchange-traded fixed-income funds (PFF, PGF, PGX, PSK, VRP), these term securities mostly are not part of the ETFs, except only for 16 issues, which are holdings of PFF.
Now that these products have our attention, we are continuously monitoring all baby bonds and term preferred securities by several groups and will reinstate our Monthly Review, publishing a recap of the groups of interest.
First, let's take a look at the main indicators that we follow and their behavior during the last month.
TNX - CBOE 10-Year Treasury Note Yield Index (TNX)
As there is no ETF that presents the instrument we're interested in, here is the most representative one for fixed income.
iShares Preferred and Income Securities ETF (PFF)
SPDR S&P 500 ETF (SPY)
The most significant indicator for all fixed-income investors, the 10-year Treasury Note Yield (TNX), has bounced again at the current rate of 1.92% from a rate of 1.70% on the first trading day of December, mainly due to the stronger-than-expected jobs report on the first Friday. Last month's non-farm payrolls up 266,000 versus 186,000 expected and the unemployment rate decline of 3.5% moved the U.S. treasuries lower. It is also essential that the US and China will sign a "phase one" trade deal in January, moving all equity markets higher, as a risk-on, to a new all-time high, and put extra pressure on the U.S. Treasuries. The fixed-income securities, in turn, started the first day of the month with tangible selling, before bouncing back driven by the bullish equity markets, with PFF having a 2% gain for several days and again moving close to its 1-year high.
In the following charts, we will examine where our term preferreds and baby bonds of interest stand currently. There are 102 issues in our database that trade on primary exchanges. Firstly, you can see two colorful pictures dividing them by sectors and by stock type:
1.1 Short-Term Baby Bonds With Call Risk, YTC < 0
The lower the bond, the higher the risk. Be careful not to get surprised in these ones if you are tempted by the higher yield. In simple terms, these securities are trading above their par value and can be subject to redemption at any time. The immediate capital loss leads to negative returns.
This is actually the best return you can get if the security doesn't get redeemed until maturity.
1.2 Baby bonds > Par, No Call Risk YTC > 0
This is the group that has no redemption risk, regardless of whether the bond is callable or not. Again, because the bonds are trading above their par value, the Yield-to-Call is their Yield-to-Worst. It is actually the yield curve of all short-term baby bonds.
The higher the stock, the better the YTW.
The Yield-to-Maturity is also the Yield-to-Best. The closer the maturity is, the higher the probability of getting the best return of the security.
1.3 Baby Bonds Between $25.00 And $25.50
This is the group of baby bonds where there is minimal call risk for their holders. Despite the fact that some of them have a negative YTC, you need just one interest payment to break-even on your investment and you can enjoy the dividend yield.
1.4 Baby Bonds < Par, By Years-To-Maturity And Yield-To-Maturity
Generally, the group consists of one of the most problematic stocks. An average Yield-to-Maturity (Yield-to-Worst) of 9.18% (flat since the last month's article) speaks enough for itself.
Arlington Asset Investment Corp.'s (AI) common stock behavior does not inspire much confidence in its baby bonds, AIC and AIW, and despite they are not so much under PAR, they are yielding at 7.99% and 7.82%, respectively.
JMP Group's (JMP) issue, JMPNZ, is a recently issued baby bond, that since its IPO is experiencing serious difficulties. Although there is no specific news, the common stock is in a constant downtrend that exists for 3 years now.
LTS' baby bonds take part in this group now after Ladenburg Thalmann (LTS) agreed to sell itself to Advisor Group (private company) and its baby bonds (OTC:LTSL, OTC:LTSF, OTC:LTSK, and OTC:LTSH) have shifted their yields to the yield of the private company yields. According to the latest data, Advisors' corporate bond has a Yield-to-Maturity of 9.56% with 7 and a half years to its maturity date.
The Medley (MDLY) "babies," MDLQ and MDLX, together with Medley Capital's (MCC) baby bonds, MCX and MCV, take part in this group due to the shareholders' concern about the potential merger of MCC, MDLY, and Sierra Income Corp. Despite the last developments, a Yield-to-Maturity of 17.20% (for MDLQ) can hardly be defined as safe, despite there are only 4 years to maturity.
2.1 Term Preferred Stocks And Third Party Trust Preferreds With Call Risk, YTC < 0
Just like the bonds, the lower the stock, the higher the risk. These are the preferred stocks with a redemption risk on it. In other words, they are trading above their par value and can be subject to redemption at any time. The immediate capital loss will lead to a negative yield.
The best return you can get if the security doesn't get redeemed until maturity.
2.2 Term Preferred Stocks And Third Party Trust Preferreds With No Call Risk, YTC > 0
This is the group of fewer than 10 years to maturity preferred stocks that have no risk of redemption by the issuer. Even if the issuer does that, you will receive their Yield-to-Call. For a clearer view, PYS and SPLP-A will not take part in the first bubble chart due to their 296% and 138% YTC, respectively.
Which preferred stocks and baby bonds with fewer than 10 years to maturity are ex-dividend until the end of February? The date given is predicted on the basis of the previous ones and may vary by a few days.
The ex-dividend dates are very useful for every fixed-income investor that practices the dividend capture strategy.
There are four issues that were called for redemption since the end of December:
Also, there are 9 short-term securities issued in the fourth quarter of 2019:
Here is the general idea of how the baby bonds and the term preferred stocks have moved since the start of the month:
This is what our small world of short-term fixed income securities looks like at the end of January. After a slight correction at the beginning of December, the fixed-income securities quickly returned to the path of buying with PFF trading at its 2-year high. Despite the heightened fears of the new coronavirus and the drop of the equity markets, the fixed-income securities have remained almost unchanged. When I am looking at all the instruments in our database, my conclusion at the moment is that the fixed income market (exchange-traded instruments) is very hard for investing. I don't see any Alpha in holding the average fixed income portfolio. I understand that many people expect that there are always some buying opportunities, but not the case for me.
Note: This article was originally published for our subscribers on 01/27/2020 and some figures and charts may not be entirely up to date.
The Trade With Beta team has been submerged in the universe of preferred stocks and baby bonds for almost a decade, and we decided to share our knowledge and expertise through the inception of this service. We attempt to cover all aspects of these products, from IPOs to pair trades and portfolio picks and, last but not least, issues. Additionally, once a month, we go through all different groups of fixed-income instruments to make sure that nothing has gone unnoticed.
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.
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.