JPI: Our Pick Among CEFs Focused On Preferreds (NYSE:JPI)

Summary

The CEF preferreds sector has begun to claw back some of its losses, however, it still remains attractive in our view relative to its pre-drawdown high.
Within the sector, we like the term fund JPI - one of a number of Nuveen preferreds CEFs.
The fund is trading at the widest discount in the sector with a very low discount sector spread. The term feature should provide an additional tailwind of 0.9% per annum.
This idea was discussed in more depth with members of my private investing community, Systematic Income. Get started today »

This article incorporates data as of Monday close.

The preferreds sector has begun to claw back some of its losses over the past week. At current levels, the sector could still push higher in both NAVs and discounts, assuming the market continues to normalize. Within the sector, we like the Nuveen Preferred and Income Term Fund (NYSE:JPI) for its very attractive absolute and relative discount, decent historic returns, and a potential tailwind from its term feature.

CEF Sector Still Provides A Good Entry Point

Taking a look at market performance of the iShares Preferred and Income Securities ETF (PFF), unlike some of the higher quality income sectors like agencies and munis, preferreds remain well underwater from the beginning of the drawdown despite lower interest rates, providing potential opportunity for further recovery.

Source: ADS Analytics, Tiingo

Taking a look at CEF sector discount moves, we can see that the preferreds sector had one of the largest discount widenings and one of the bigger retracements.

Source: ADS Analytics, Tiingo

The preferreds sector, along with everything else, has begun to recover from last week's sell-off. The sector, however, remains as one of the most beaten down in discount terms.

Looking at the overall move in discounts still leaves the sector with one of the biggest discount widenings which, in our view, still provides an attractive opportunity.

Source: ADS Analytics, Tiingo

JPI - Our Pick In The Sector

Within the sector, we like the Nuveen Preferred and Income Term Fund (JPI). In terms of allocation, the fund is quite financials-heavy with 77% of the portfolio composed of banks, financial services, insurance and capital market issuers. The fund carries about 30% of its assets in contingent convertible securities with total non-US securities clocking in at 41%.

The fund runs $885m total assets at a 1.33% fee which is slightly above the sector average. The fund is trading at a 6.77% current yield and a 4.07% discount - the widest discount in the sector. The fund has a share repurchase program in place although it has not yet acted on it.

JPI is trading at a significant discount differential to the rest of the sector and close to a 5-year low. In absolute terms, the discount is the widest in the sector and the discount percentile, calculated from 2000, is one of the few in the sector below 50%.

Source: Systematic Income CEF Investor Tool

In terms of historic returns, the fund has slightly underperformed over the longer 5-year basis, however, it has beaten the sector over the past year.

Source: Systematic Income CEF Investor Tool

The fund has $295m of leverage composed of a $235m facility and a $60m repo on which it pays 1M Libor + 0.70% - at the lower end of what we've seen on credit risky assets. It has locked in the cost of leverage by hedging $157m of its Libor exposure according to the latest report. This means that while on an aggregate basis, the fund has benefited from the drop in short-term rates, it has not gained as much as it could have had it gone unhedged.

The fund's distribution coverage has held fairly steady at around 104%-102% over the last year or so.

Source: Systematic Income CEF Investor Tool

The term feature of the fund should provide an additional tailwind to fund performance. Term funds generally hold two risks: one is that the fund actually fails to terminate leading to potential discount widening and two, that the fund deleverages into the termination. Nuveen has generally been a good industry player in delivering on their fund terminations or at least providing an option to tender at NAV. And JPI is not a target term fund which means that we don't expect it to deleverage into the termination in order to hit a particular NAV target.

Assuming the fund does terminate at NAV in August 2024, we would expect the current discount to amortize towards zero, providing an additional boost of about 0.9% per annum on top of its covered yield of 6.90%.

The term feature provides an additional benefit - lower price volatility. As the termination date approaches, the volatility of the discount should keep decreasing which, apart from keeping behavioral monsters at bay, will make the fund even more attractive on a yield-to-risk basis.

Conclusion

The preferreds sector sold off sharply in the past week and as of Monday close remains about 4% off its peak despite a rally in interest rates judging by the sector ETF. The CEF sector discount widening is also one of the larger ones through this recent sell-off. Within the sector we like JPI - a term fund that is trading at the widest discount in the sector and a very low historical spread to the sector. The fund has delivered solid historical returns and the term feature should provide an additional return tailwind.

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This article was written by

ADS Analytics

10.29K Followers

ADS Analytics is a team of analysts with experience in research and trading departments at several industry-leading global investment banks. They focus on generating income ideas from a range of security types including: CEFs, ETFs and mutual funds, BDCs as well as individual preferred stocks and baby bonds.

ADS Analytics runs the investing group Systematic Income which features 3 different portfolios for a range of yield targets as well interactive tools for investors, daily updates and a vibrant community.

Analyst’s Disclosure: I am/we are long JPI. 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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