PFF - FPEI: Another Instrument To Play The Regional Banks Crisis

2023-03-28 17:51:51 ET

Summary

• The First Trust Institutional Preferred Securities and Income ETF is a preferred securities fund.
• The fund is overweight bank preferred securities, with insurance and capital markets being the next highest segments.
• Diversification and granularity have been the most important factors this year for an aggregator like FPEI.
• FPEI is an alternative to the much better-known iShares Preferred and Income Securities ETF (PFF).
• The fund has a low 3-year standard deviation of 12.19.

Thesis

The First Trust Institutional Preferred Securities and Income ETF ( FPEI ) is an actively managed exchange-traded fund focused on preferred securities:

Under normal market conditions, the fund invests at least 80% of its net assets (including investment borrowings) in institutional preferred securities and income-producing debt securities.

The fund is overweight bank preferred securities, with insurance and capital markets being the next highest segments. As the regional banks' crisis has raged in the U.S. investors have been fixated on how to take advantage of the sudden drop in prices.

We have seen certain investors migrate towards distressed single-name plays, only to be wiped out by bankruptcies, such as the one observed for SVB and SBNY. FPEI is an aggregator that offers granularity and diversification. The fund is an alternative to the much better-known iShares Preferred and Income Securities ETF ( PFF ) which we covered here . The downside to FPEI is that it has a very high management fee of 0.85% when compared to PFF's 0.45% expense ratio.

On a risk-metrics basis, FPEI is less volatile:

We can see the fund having a lower standard deviation when compared to PFF. Similarly, the risk-adjusted metric Sharpe ratio is higher for FPEI. From a returns perspective, however, FPEI underperforms PFF long-term.

PFF also has a high concentration of preferred securities from regional banks, whereas PFEI's figures are smaller. FPEI is designed for a more conservative, volatility adverse investor under its current format.

One lesson to be learned from the current banking crisis is that diversification and granularity are important. Investors who suffered substantial losses were the ones who had high concentrations in individual names. Taking a position in the bank preferred equity market via ETFs or CEFs is preferable at this stage since it does not require any 'homework'. An investor does not need to pour over balance sheets and income statements or analyze the market segmentation for any single name. An investment via an aggregator simply takes advantage of the cyclicality of the market, while taking out single-issuer risk.

FPEI Holdings

The fund is overweight bank and financial services preferred shares:

We can see that the cumulative total of banks, insurance companies, and capital markets corporations account for over 73% of the fund's portfolio. While the rest of the industries do provide for a little bit of diversification, make no mistake about it - this fund's performance is run by bank preferred risk.

The vehicle's portfolio is generally investment grade:

While ratings matter in the long run, what we have seen in 2023 is the propensity for ratings to be obsolete. All the banks that failed and had the preferred shares wiped out exposed investment grade ratings on the preferred stock prior to the recent events. Maybe that is why the rating agencies are now aggressively downgrading names, with First Republic Bank ( FRC ) taking the brunt of the rating agencies' actions.

Diversification and granularity have been the most important factors this year for an aggregator like FPEI. We do have both in this portfolio:

We can see from the top holdings table that no individual issuer accounts for more than 3.51% of the fund currently, which is a positive feature. The riskiest pockets in the market have the following weightings in this fund:

CoCo/AT1 bonds are the ones similar to the Credit Suisse ( CS ) one, which got wiped out. This fund actually had a slice of that name, so it lost a bit more than 1% of its portfolio via that default. There is very little regional bank exposure here.

Historic Performance

The fund has underperformed ( PFF ) in the past year:

We are looking at total return here so that dividends can be incorporated. One of the main reasons driving the recent underperformance is the fund's position in the Credit Suisse AT1 bonds that got wiped out. They used to account for a little bit more than 1% of the portfolio.

Longer term, FPEI also underperforms PFF:

Conclusion

The First Trust Institutional Preferred Securities and Income ETF is an actively managed exchange-traded fund focused on preferred securities. The vehicle is overweight bank and insurance preferred securities, and represents an alternative to the much better-known iShares Preferred and Income Securities ETF, which we covered here . FPEI is less volatile than PFF but has lower long-term results and a higher management fee. The fund takes less risk to regional banks and has a deep and diversified portfolio. The fund has however suffered a full attachment for one of its securities - FPEI was an owner of the ( CS ) AT1 bonds, which accounted for a bit more than 1% of the fund. In the unleveraged space, FPEI offers a nice play on the banking crisis.

Author Disclosure: The above article is an informational analysis and should not be construed as investment advice. Please excuse any typos in the article if present.

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