This article was originally published on 21-Feb.
The CEF preferreds sector is often overlooked by investors due to its low average liquidity and low average yields. The sector, however, has significant variation and a combination of historic resilience and attractive yields. In this article, we discuss the three sub-sectors within this income sector and our picks. Specifically, we highlight the following preferreds:
- Gabelli Equity Trust 5% Series K (GAB)
- Gabelli Multimedia Trust 5.125% Series G (GGT.PG)
- RiverNorth/DoubleLine Strategic Opportunity Fund 4.375% Series A (OPP.PA)
- RiverNorth Specialty Finance Corp 5.875% Series A (RMPL.P)
- Priority Income Fund 6.625% Series C (PRIF.PC)
Redemptions As A Theme
Redemptions have been a persistent theme of the preferreds market. Unusually, for the retail preferred market, fourth quarter 2020 net issuance was actually negative. Over the whole year, however, the sector grew, though at a slower pace from the previous year.
The CEF preferreds sector was not immune to redemptions. A number of CEF preferreds have been called this year, three from the Gabelli suite of funds, in particular. These three redemptions have followed the recent pattern of delivering losses to current holders as they have tended to trade significantly above "par" prior to the redemption. The chart below captures the dividend-adjusted price return of one of the stocks that were redeemed and shows the redemption delivered a negative hit on the day of nearly 4% to holders which is only a bit larger than the negative hits on the two other redemptions.
Source: Systematic Income
Though clearly negative for investors, it's hard to get too excited about these one-off negative return hits, particularly, for investors who have been long-term holders of the stocks and made a calculation to take the risk of redemption. Gabelli have not made redemptions on economic criteria and these three stocks have traded above "par" for long periods after their first call date. That said, the pace of redemptions from Gabelli has stepped up so we would be wary of holding any currently callable preferreds from their suite that are trading above "par".
The CEF Preferreds sector is composed of three sub-sectors: CLO CEF preferreds, fixed-income CEF preferreds and equity CEF Preferreds.
Source: Systematic Income
These three sub-sectors have substantially different risk profiles with the equity-linked CEF preferreds being the most resilient due to the very strong average asset coverage and low CEF leverage. The equity CEF preferreds are also attractive as most have investment-grade ratings and have no debt (i.e. repo, credit facilities or baby bonds) ahead of the preferreds in the capital structure.
Within the equity CEF sub-sector we like the A1-rated Gabelli Equity Trust 5% Series K (GAB), trading at a 4.86% stripped yield and a 4.18% yield-to-call to a 16-Dec-2024 first call date. The stock has estimated asset coverage of 456%. Somewhat unusually for this sub-sector it also has decent trading volume.
We also like the A2-rated Gabelli Multimedia Trust 5.125% Series G (GGT.PG), trading at a 4.94% stripped yield and 4.08% yield-to-call to a 20-Dec-2024 first call date. The stock has 330% asset coverage.
The two underlying CEFs had NAV drawdowns of around 50% in 2020 which wouldn't have come close to falling below 1x asset coverage.
Preferreds in the fixed-income CEF sub-sector tend to have lower NAV drawdowns in the underlying CEFs but also boast lower levels of asset coverage as well as some having debt ahead of the preferreds in the funds' capital structure.
Within the sub-sector we like the A1-rated RiverNorth/DoubleLine Strategic Opportunity Fund 4.375% Series A (OPP.PA), trading at a 4.58% stripped yield which is also the stock's yield-to-worst (given it is trading below "par" which makes the yield-to-call higher than the stripped yield). We estimate asset coverage at around 271% with some debt ahead of the preferreds in the capital structure. On the plus side, the fund's NAV drawdown in March was only 28%. The fund is allocated primarily to MBS, about 2/3 of that in non-agency securities. About a quarter of the fund is in investment-grade rated assets.
We also like the RiverNorth Specialty Finance Corp 5.875% Series A (RMPL.P)which is trading at a 5.85% stripped yield and a slightly negative yield-to-call as it is slightly over par and is currently callable. Picking up the stock right around par minimizes the negative hit in case of a redemption. We estimate the asset coverage around 362%. There is also no debt in the capital structure and the NAV drawdown in 2020 was only 23%, both big pluses for preferreds holders.
Within the CLO equity senior security space we have tended to like either the Eagle Point Credit Company (ECC) baby bonds which are higher up in the capital structure from the preferreds or the OFS Credit Company 6.875% Series A (OTC:OCCIP). However, two of these three securities are trading at negative yield-to-call and the yield-to-call of the third is below 5%.
This is why for a new position in the sub-sector we like the Priority Income Fund 6.625% Series C (PRIF.PC), trading at a 7.55% yield-to-maturity. The first call date is just a few days away, however, it is unlikely as the stock is trading about 3% below "par". The other attractive feature of the stock is the 2024 maturity date which limits the impact from rising rates.
The CEF preferreds sector remains attractive as part of a broader income portfolio. The sector has remained resilient in 2020, reversing all of the losses in short order. Two of the sub-sectors feature mostly investment-grade rated stocks (the rest being unrated but of comparable quality, in our view). The CLO equity preferreds sub-sector is more speculative, however, it was defended by its fund managers who deleveraged and bought back their senior securities in order to support asset coverage. And unlike the vast majority of preferreds, they feature maturities which limits their sensitivity to interest rate rises.
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