Within the broader fixed-income umbrella, PTA features a decent-quality profile, holding preferreds of primarily investment-grade household-name issuers.
The fund’s preferred portfolio itself is about a third investment-grade with more than half allocated to securities rated BB+ (i.e., the highest sub-investment-grade rating) and above.
The fund trades at the widest discount in the sector – about 8% wider than the sector average, despite modest outperformance year-to-date.
Below we discuss in more detail why holding some higher-quality preferred exposure makes sense and why PTA looks attractive within its sector. Overall, our approach to the preferreds sector is to identify attractive fund families at any given time. Once identified, we tilt to the most attractive fund in that fund family.
The reason we view the Cohen and Steers preferreds funds positively has to do primarily with their leverage resilience as well as their duration and borrowing cost hedge.
The allocation profile of the three funds in the Cohen preferred CEF (PSF, LDP, PTA) suite is not identical, but it’s not hugely different. All three funds have a credit rating profile of 66-72% in securities rated BB and above. All three are overweight Banks (54-60%). All three are overweight U.S. securities (52-64%). Perhaps the biggest difference is in the retail preferred allocation with PTA having the largest at 26% versus 14% and 9% for the other 2 funds.
Overall, this hasn’t made a ton of difference to the performance of the three funds since 2021 (PTA launched in late 2020). LDP has outperformed by about 1% per annum since then, however that has only happened in the last few months – we suspect due to its slightly lower duration profile (which is literally in the name of the fund).
In short, the allocation differences do exist but they are not where we have particularly strong views. Where the real action is, in our view, is in the income profile.
The funds’ income profile is a function of their valuation and features. The key features in our view is that PTA has a 1% management fee while the other two funds have a 0.7% fee. However, PTA has fixed 85% of its leverage cost at just 1.2% versus 1.7% for the other two funds. PTA also has a slightly higher leverage than the other two funds. Plus, PTA trades at a slightly wider discount than LDP and a significantly wider discount than PTA.
A lot of investors get hung up on discounts, but they are just part of the puzzle. What we need to do is line everything up on an apples-to-apples basis and see how the CEF income sausage factory looks.
LDP and Cohen & Steers Select Preferred and Income Fund, Inc. (PSF) are quite similar to each other – they have the same management fee, similar leverage level and the same leverage cost so we pick LDP to go up against PTA given LDP is trading at a significantly wider discount than PSF.
This is how the net yield picture stacks up between the two funds. We assume a portfolio yield of 6.5% – again, we don’t need to get this exactly right since what we are after is a relative picture between the two funds.
PTA generates a bit more additional yield due to its slightly higher leverage level. LDP has a lower yield drag of 1.06% (versus 1.59% for PTA) due to its lower management fee. PTA, as expected, has a lower leverage cost and also generates more yield due to its slightly wider discount. Net net PTA comes out ahead by a higher net yield of 0.28% which is the reason why it’s our pick in the suite at the moment. Outside of the Cohen suite, we estimate PTA to have the highest net yield in the sector due to its wide discount and low leverage cost.
We expect the macro and market environment to remain highly uncertain, at the very least until inflation convincingly peaks and begins to descend. This is why we view decent-quality fixed-income assets such as preferreds worth an allocation in diversified income portfolios. In addition, the margin-of-safety valuation of PTA as well as its mostly fixed and low leverage cost profile will allow it to maintain its income level at a stable and high level in the sector.
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