PTA - Closed-End Funds: Cohen & Steers Preferred Trio

2023-11-25 06:21:07 ET

Summary

• Cohen & Steers offers three preferred funds focused on preferred investments: PTA, LDP, and PSF.
• The funds have historically outperformed the iShares Preferred & Income Securities ETF and are currently trading at relatively attractive levels.
• Higher interest rates have impacted the performance of preferred securities, but the future could be brighter if we are near the end of this rate hiking cycle.

Written by Nick Ackerman, co-produced by Stanford Chemist.

Cohen & Steers ( CNS ) is a smaller asset manager that's generally focused on real estate investing. They offer several closed-end funds specifically focused on that area of the market as well. However, they also generally carry exposure to preferred investments as well. Even their more popular real estate-focused CEFs have some exposure to preferreds.

Today, I wanted to provide an update across all three of their preferred funds that are specifically focused on preferred investments. Those three funds include Cohen & Steers Tax-Advantaged Preferred Securities and Income Fund ( PTA ), Cohen & Steers Limited Duration Preferred and Income Fund ( LDP ) and Cohen & Steers Selected Preferred and Income Fund ( PSF ).

The Basics

PTA

• 1-Year Z-score: 1.24
• Discount: -6.60%
• Distribution Yield: 9.30%
• Expense Ratio: 1.73%
• Leverage: 36.41%
• Managed Assets: $1.62 billion
• Structure: Term (anticipated liquidation date is October 27th, 2032)

PTA's investment objective is quite simple, "high current income." They also have a secondary objective that is similarly simple, "capital appreciation."

To achieve this, they will invest "at least 80% of its managed assets in a portfolio of preferred and other income securities issued by U.S. and non-U.S. companies, which may be either exchange-traded or available over-the-counter." They also will "seek to achieve favorable after-tax returns for its shareholders by seeking to minimize the U.S. federal income tax consequences on income generated by the Fund."

PTA is the youngest of the trio of preferred funds offered by CNS, and it is also structured as a term fund. That means the fund is expected to be liquidated in the future and NAV (whatever it might be at that time) be returned to investors.

LDP

• 1-Year Z-score: 0.57
• Discount: -7.37%
• Distribution Yield: 8.98%
• Expense Ratio: 1.27%
• Leverage: 35.78%
• Managed Assets: $866.44 million
• Structure: Perpetual

LDP's investment objective is "high current income through investment in preferred and other income securities. The secondary investment objective is capital appreciation." As stated, they attempt to achieve this through investing in preferred and income securities, but they leave it quite flexible. That can include "U.S. and non-U.S. companies like banks, insurance companies, REITs, other diversified financials as well as utility, energy, pipeline and telecommunication companies."

PSF

• 1-Year Z-score: 2.43
• Premium: 0.16%
• Distribution Yield: 8.40%
• Expense Ratio: 1.35%
• Leverage: 36.07%
• Managed Assets: $350.64 million
• Structure: Perpetual

PSF's investment objective is "high current income," with a secondary objective being "capital appreciation." They attempt to achieve this through "investments in preferred and other income securities." Those can include U.S. or non-U.S. companies across various sectors.

PSF is the oldest of the funds, with an inception date in late 2010. It is also the smallest of the trio, which can present some difficulties for larger investors wanting to buy or sell quickly.

Overall, all three of the funds are the same in terms of their objectives and how they invest to achieve those objectives. This leads to their portfolios having quite a bit of overlap and, therefore, similar total return results, as we'll see. As far as PTA's "tax-advantaged" part of its name, most preferred pay qualified dividends anyway, so that isn't as unique as it may first appear.

Preferreds And Performance

Preferred securities were hit hard during the banking crisis earlier this year , and that was after higher interest rates had also been wreaking havoc on these funds. The majority of preferred are issued by financial institutions to help meet regulatory requirements. The bulk of the exposure of most preferred funds, in general, is to the financial sector unless they specifically design a fund differently. With that being said, since that big March plunge, things have been relatively stable, but discounts on these funds remain wide and attractive.

Besides the attractive discounts on the CEFs themselves, preferred are also trading at their own discounts thanks to higher interest rates. This has recently been highlighted as one of the attractive opportunities for preferred investments by Cohen & Steers .

Now, we can take a look to see how the trio of funds have been performing. First, we can take a look at the results since PTA's launch. As the newest fund that launched at the end of 2020, we are limited in how far back we can go on this initial chart.

During this time, PTA has performed the worst on both a total share price and NAV return basis. In fact, as we can see on a share price basis, it was a material difference. That's also easy to explain; it's simply that a fund launches at parity with its NAV per share and then generally drops to a substantial discount. Thus, share price performance hardly ever has a chance to be positive a year or two after launch. Mix in an aggressive rate hiking cycle, and PTA stood no chance of performing well a few years later after launch.

With that being said, the fund's performance over the last year has been much more competitive. It even beat out its sisters in terms of share price as the discount contracted a bit during this period.

All three of the funds here had outperformed the passively managed iShares Preferred & Income Securities ETF ( PFF ). Though, note that PFF is only focused on preferreds, whereas the CNS preferred trio can get into a bit more eccentric investments such as contingent convertible securities (CoCos), also called AT1 bonds. These are European securities and are what blew up when Credit Suisse saw theirs written off to zero.

That's part of the reason why PFF held up much better during the March banking crisis. However, the leverage utilized in the preferred CEFs also would have clearly played a role as well.

Finally, let's take a look at the longer-term results of LDP and PSF relative to PFF, where we can go back over the last decade to see the results. In this case, both LDP and PSF had outperformed PFF significantly.

Given the fact that it was a zero-rate environment through most of this period clearly played a role. That meant that their leverage cost was incredibly low, and investing even in lower-yielding preferred at the time could make sense. Today, they have to be more selective in what they can invest in to create a positive spread above their leverage costs. Borrowing costs for these funds are now pushing ~6%+.

Fortunately, all three of these funds are largely hedged against this with interest rate swaps for the next few years. Meaning they haven't experienced the full brunt of higher rates just yet, as gains offset these rising costs and hits to NII.

However, even considering the zero rate environment to today's higher rates can also have a positive impact. Higher rates also mean that any new preferred being issued is going to have to have a higher yield to garner interest, and that means higher income generation potential for the funds.

Another highlight from the CNS team in their recent article gave examples of several preferreds resetting to higher rates. They invest significantly in fixed-to-float securities, which, as these start to kick in, should provide higher yields. This is happening even in investment-grade securities, so it doesn't mean they have to go lower in the credit quality ladder to achieve yields that can make sense to hold today.

Often, companies had been simply calling these preferred as they started to float. However, in a higher interest rate environment, that might not always make sense to do right away because it can't necessarily be replaced with cheaper financing.

The Best Bargain And Distributions

On an absolute basis, LDP is the best bargain today with its attractive discount. PSF has more recently popped back up to start trading at a premium.

However, on a relative basis, historically, all of these funds are looking like they could be tempting candidates worth considering. Even with PSF climbing to a premium, it isn't overly expensive on a relative basis. They are all trading below or near their longer-term average discounts. That includes PTA, though 'long-term' here is a relatively shorter period of time. Still, LDP looks like the best price in today's market.

LDP and PSF both cut their distributions this year as they did to start off in 2022 as well. PTA, on the other hand, raised its distribution at the start of 2023. It didn't seem warranted, in my opinion, because coverage of the distribution hadn't improved but was actually falling as it was across all the CNS preferred funds.

In fact, any leveraged CEF saw falling net investment income due to rising borrowing costs. That's even if they were hedged or not, but those that were hedged would have seen it offset by capital gains to a certain degree.

Today, PTA has the highest NAV distribution rate. At a rate of 8.49%, we aren't looking at nosebleed levels, though. LDP currently sports an 8.06% NAV rate, and PSF is at 7.93%.

What might be more interesting about these moves to note is how it played out on the discounts here. Generally, when a fund cuts, it gets pressured to start trading at a discount. In this case, it would appear that PSF has mostly been able to thwart that drop when compared to LDP. That could perhaps be that over the longer term, PSF had generally traded at a higher valuation. We also see that even with a distribution boost, it seemed to do little to keep PTA investors from letting the fund drop to a significant discount.

Conclusion

PTA, LDP and PSF are all interesting funds worth considering in the preferred space. They had historically provided some solid results but have been beaten down now by higher rates. This is precisely what makes them more interesting today and buying while they are down and discounted.

Not only are the funds discounted at the fund level, but preferred are discounted to their par levels as well. If we are near the end of the rate hiking cycle, we can continue to stabilize in the preferred space as we've seen since March. If rates are cut as they are expected to be next year, that could see a significant rebound in preferred securities. From 1990 to 2023, there have been four rate hiking cycles that have come to an end. Cohen & Steers noted that the average return 12 months after the last hike resulted in preferreds running up 14.2%. That means despite the black swan events that caused rates to be slashed, preferreds still performed impressively.

However, expect these funds to be more volatile as they employ leverage through borrowings. Those costs are also rising, but they have a significant amount of their leverage hedged via interest rate swaps. That has given them a few years to really have to worry about higher rates, and during that time, if rates stay elevated, then the underlying holdings that they are also buying should see yields rise as well. As those yields rise, NII should also start heading upward. Alternatively, if rates are cut, that's another good thing for these funds, as borrowing costs would also drop.

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