JPS - JPS: Providing Income To Support Your Lifestyle

2023-07-07 13:04:54 ET

Summary

• Investors are in desperate need of income to sustain their lifestyles in the face of the rapidly-rising cost of living.
• Nuveen Preferred & Income Securities Fund invests in a portfolio of fixed-income securities and then applies a layer of leverage to provide a very high yield to its shareholders, providing much-needed income.
• The Fed has stated that it will raise rates twice more this year, which will almost certainly push down bond prices from their present levels.
• The JPS CEF has had to cut its distribution twice in the past year, but it appears that the fund is trying to pay out only its NII and net realized gains.
• The fund is currently trading at a very attractive discount to the net asset value.

There can be little doubt that one of the biggest problems facing the average American today is the rapidly rising cost of living. Over the past two years or so, the United States has experienced the highest inflation rate that it has seen in about forty years, which is clearly evidenced by the consumer price index. As we can see here, the index has posted a year-over-year growth rate of more than the 2% which is considered healthy during each of the past twelve months:

As of the time of writing, real wage growth has been negative in the United States for 26 straight months. Thus, anyone depending on their job to support their lifestyle has seen their finances increasingly strained over the past year or two. As I mentioned in a previous article , it has now gotten to the point where consumers are relying on credit cards and even pawn shops just to make ends meet. This could also be a reason why the jobs reports have been coming in fairly strong despite all other economic indicators pointing to a recession. In short, people are clearly desperate for additional sources of income to make ends meet.

As investors, we are certainly not immune to this. After all, we need money to pay our bills, buy food, and enjoy some of the niceties in life. These things have all gotten somewhat more expensive recently due to inflation. Fortunately, we do have methods that we can employ to obtain some additional income that does not require getting a second job or doing odd tasks. For example, we can put our money to work for us earning an income. One of the best ways to do this is to purchase shares of a closed-end fund, or CEF, that specializes in income generation.

These funds are unfortunately not very well followed in the financial media and most investment advisors are somewhat unfamiliar with them. As such, it can be difficult to obtain the information that we would like to have in order to make an informed decision about purchasing a security. That is a shame because these funds have a few advantages over more familiar open-ended or exchange-traded funds. In particular, a closed-end fund is able to employ certain strategies that have the effect of boosting its yields well beyond that of anything else in the market or the underlying assets.

In this article, we will discuss the Nuveen Preferred & Income Securities Fund ( JPS ), which yields 7.22% at the current price. This is certainly enough to turn the eye of any investor that is seeking to earn a high level of income from their portfolio. I have discussed this fund before, but several months have passed since that time so naturally a few things have changed. This article will focus specifically on these changes as well as provide an updated analysis of the fund's financial condition. Therefore, let us investigate and see if this fund could be a good addition to your portfolio.

About The Fund

According to the fund's webpage , the Nuveen Preferred & Income Securities Fund has the stated objective of providing its investors with as high a level of current income as possible while still preserving the value of its principal. This is not particularly surprising considering that the name of the fund implies that this is a fixed-income closed-end fund. This is certainly the case as the fund's assets are split between preferred stock and bonds:

As we can clearly see, 53.02% of the fund's portfolio is invested in bonds and 45.16% is in preferred stock. This is a slightly larger allocation to preferred stock than the last time that we looked at the fund, but overall the difference is negligible. We can still see that preferred stock and bonds account for the overwhelming majority of the fund's assets. This is important because of the characteristics of these securities, which are quite similar.

In short, an investor purchases a bond at face value when it is issued, receives a regular payment from the issuing company, and then receives their money back at the bond's maturity. Thus, the only investment return that a bond actually delivers over its lifetime is the regular interest payment. It does not provide any net capital gains due to the fact that it has no inherent link to the growth and prosperity of the issuing company. After all, a company will not increase the amount that it pays its creditors just because its income increases. A preferred stock works much like a bond, except that it does not have a maturity date.

With that said, it is possible for an investor to take advantage of the fact that bond and preferred stock prices do change from day to day by trading them to others in the market. For the most part, it is an inverse relationship so bond prices go down when interest rates go up and vice versa. This is because newly issued bonds will have a yield that corresponds with the current market interest rate so the market price of existing bonds has to adjust so that they deliver a similar yield to maturity as a brand-new bond. As everyone reading this is no doubt aware, the Federal Reserve has been aggressively raising interest rates over the past sixteen months or so in an effort to combat the high inflation rate that is plaguing the economy. As we can clearly see here, the federal funds rate is currently at the highest level that it has been in years:

As of the time of writing, the effective federal funds rate is 5.08% compared to 0.08% back in February 2022. This has had the effect of pushing down the price of most bonds due to the inverse relationship between price and interest rates that was just discussed. We can see the impact here by looking at the Bloomberg U.S. Aggregate Bond Index ( AGG ), which was down 4.75% during the twelve-month period ending on March 31, 2023:

The fund has rebounded a bit since then and is currently down 2.13% over the past year. This is despite the fact that the Federal Reserve has increased interest rates further since March. The biggest reason for this is that the market expects that the Federal Reserve will cut rates in the near future as the economy descends into a recession. For its part, the Federal Reserve has stated that this will not happen and has guided for two more rate hikes this year. If the Federal Reserve actually shows integrity and follows through on this guidance, it will almost certainly cause a bond market selloff.

The Nuveen Preferred & Income Securities Fund has certainly not been immune to this. As of the time of writing, the fund is down 13.42% over the past year:

We can see that this fund has not rallied since March and it is down 8.80% year-to-date. Thus, it may better reflect the Federal Reserve's interest rate guidance than the Bloomberg U.S. Aggregate Bond Index. As I have pointed out before, though, it is not unusual for the market performance of a closed-end fund to be somewhat different than the performance of its actual portfolio. As of June 30, 2023, the Nuveen Preferred & Income Securities Fund delivered a -2.32% total return on its portfolio year-to-date, which is better than the -2.83% total return of the share price over that period. This latter figure assumes reinvested distributions, so that is the biggest reason why these numbers are much better than the figures reflected in the chart above. Whether an investor will actually get the total return depends on whether or not the distributions are reinvested in the shares of the fund, and it is unlikely that someone seeking income will do this.

In my last article on the Nuveen Preferred & Income Securities Fund, I pointed out that the fund is heavily invested in the banking sector. This is still the case, as 49.1% of the fund is currently invested in diversified banks:

This could be concerning considering that the past few months have seen some of the largest bank failures in history. These failures were caused mostly by the carnage in the bond market over the past year, as the U.S. Treasury securities that are held by many banks have declined significantly in price. Thus, the banks cannot actually sell them in order to get the money needed to satisfy depositor demands in the event of substantial withdrawals. However, the problem is not that the securities are toxic as the U.S. Treasury has continued to make payments on them and will still redeem them at maturity. Thus, banks are generally in better financial shape than may be thought. The problem is that they are sitting on unrealized losses in Treasuries that are now worth less than the amount of money that depositors have put into their accounts.

It is very common for any fund that invests heavily in preferred stocks to have substantial exposure to the banking sector. This is because banks are by far the largest issuers of preferred stock in the market due to regulatory requirements. In short, regulators require that a bank maintain a certain percentage of its assets as Tier One capital, which is that proportion of a bank's assets that are not simultaneously a liability to someone else (such as a depositor). When a bank is required to increase its Tier One capital, it must issue either common stock or preferred stock, but most banks will opt to issue preferred stock in order to avoid diluting the shareholders. These regulatory requirements do not apply to companies in other sectors and thus most non-banks will issue debt when they need to raise money. This is because debt is much cheaper than preferred stock. Thus, the banking sector is by default the largest issuer of preferred stock in the market and any preferred stock fund will have an outsized allocation to the sector.

The iShares Preferred and Income Securities ETF ( PFF ), which is the most popular preferred stock index fund, currently has 71.31% exposure to financial institutions, so the Nuveen closed-end fund seems to be conservative in terms of its exposure to the financial sector. Anyone worried about the banking sector will probably appreciate this.

Leverage

As stated in the introduction to this article, closed-end funds such as the Nuveen Preferred & Income Securities Fund have the ability to employ certain strategies that can boost their effective yields well above that of the securities in the portfolio. This is something that has been very important for fixed-income funds this century because fixed-income yields have been consistently low in most developed nations. One of the strategies that is employed by this fund is the use of leverage. In short, the fund borrows money and uses that borrowed money to purchase preferred stocks and bonds. As long as the purchased securities have a higher yield than the interest rate that the fund has to pay on the borrowed money, the strategy works pretty well to boost the effective yield of the portfolio. This fund is capable of borrowing money at institutional rates, which are considerably lower than retail rates, so this will usually be the case. With that said, the use of leverage for this purpose is not as effective with rates at 5% as it was when rates were at 0%.

However, the use of debt in this fashion is a double-edged sword. This is because leverage boosts both gains and losses. Thus, we want to ensure that the fund is not employing too much leverage since that would expose us to too much risk. I generally do not like to see a fund's leverage exceed a third as a percentage of its assets for this reason. Unfortunately, this fund exceeds this level as its levered assets comprise 36.14% of its portfolio as of the time of writing. This is a bit lower than the leverage that the fund had the last time that we discussed it, and it is probably okay despite it being above the level that we really want to see. A fixed-income fund can generally sustain a higher level of debt than an equity fund due to the lower volatility of the securities that it invests in. When combined with the fact that this fund is not very much above our 33% requirement, we should not have to worry too much about its leverage. Overall, the balance between risk and reward here seems to be acceptable.

Distribution Analysis

As mentioned earlier in this article, the primary objective of the Nuveen Preferred & Income Securities Fund is to provide its investors with a high level of current income. In order to achieve this objective, it purchases fixed-income securities that primarily deliver their investment returns through direct payments to the shareholders. Thus, these securities tend to have higher yields than common stocks. This fund goes a step further and applies a layer of leverage to boost the effective yield of the investment portfolio. As such, we can probably assume that it will boast a very high yield. This is certainly the case as the Nuveen Preferred and Income Securities Fund pays a monthly distribution of $0.038 per share ($0.456 per share annually), which gives it a 7.22% at the current price. Unfortunately, this fund has not been particularly consistent about its distribution over the years and has both raised and cut its distribution numerous times:

In the past year, the fund has cut its distribution twice. This is not something that will endear the fund to any investor that is seeking a stable and secure source of income to use to pay their bills or finance their lifestyles. However, it is not unusual for a fixed-income fund. These funds regularly change their distributions alongside interest rates. The fact that it has been cutting its rate recently is confusing though considering that any newly purchased securities will have a much higher yield than maturing ones so the fund's income should rise over time. Unfortunately, the fact that rates were raised so quickly meant that the fund took a lot of both realized and unrealized losses as the securities that it purchased prior to the series of rate hikes fell in value. These losses more than offset the fact that newly purchased securities are providing more income than older ones with lower yields.

However, anyone purchasing today will receive the current distribution at the current yield. As such, they do not have to worry about the fund's past. The most important thing for anyone today is how well the fund can sustain its current distribution. Let us investigate this.

Fortunately, we have a somewhat recent document that we can consult for that purpose. The fund's most recent financial report corresponds to the six-month period that ended on January 31, 2023. This is nice because it will give us a good idea of how well the fund handled the series of large rate hikes during the second half of last year. It is also a newer report than we had available the last time that we discussed this fund, which is quite nice as it will give us better insight into the fund's financial condition and the sustainability of its distribution.

During the six-month period, the Nuveen Preferred & Income Securities Fund received $9,823,637 in dividends and $67,678,729 in interest from the assets in its portfolio. When we combine this with a small amount of income from other sources, the fund had a total investment income of $77,594,417 over the six-month period. It paid its expenses out of this amount, which left it with $43,903,893 available for shareholders. That was unfortunately not enough to cover the $53,073,479 that it paid out to the shareholders. This is something that will almost certainly be concerning at first glance as we normally like to see fixed-income funds covering their distributions out of net investment income.

As low interest rates have severely limited the ability of fixed-income funds to generate income through traditional means over the past decade, most of them have resorted to generating money by using other methods. This one is no exception, as it has been engaging in trading bonds to get money through capital gains that can be distributed to investors. This fund did, surprisingly, have some success at this during the six-month period. The fund achieved net realized gains of $5,516,456 but these were partially offset by $2,659,790 net unrealized losses.

Overall, the fund's assets went down by $6,312,920 after accounting for all inflows and outflows during the period. Thus, it failed to cover its distributions fully, although net investment income plus net realized gains got pretty close. This explains the distribution cut as it appears that this fund is trying to only pay out its net investment income plus net realized gains. Thus, the distribution is probably sustainable as long as the fund can earn comparable capital gains to those of the second half of last year going forward. This is probably possible unless the Federal Reserve does crash the bond market again by following through on its current rate hike guidance instead of cutting as the market expects.

Valuation

It is always critical that we do not overpay for any asset in our portfolios. This is because overpaying for any asset is a surefire way to earn a suboptimal return on that asset. In the case of a closed-end fund like the Nuveen Preferred and Income Securities Fund, the usual way to value it is by looking at the fund's net asset value. The net asset value of a fund is the total current value of the fund's assets minus any outstanding debt. It is therefore the amount that the shareholders would receive if the fund were immediately shut down and liquidated.

Ideally, we want to purchase shares of a fund when we can obtain them at a price that is less than the net asset value. This is because such a scenario implies that we are purchasing the fund's assets for less than they are actually worth. That is, fortunately, the case with this fund right now. As of July 6, 2023 (the most recent date for which data is available as of the time of writing), the Nuveen Preferred and Income Securities Fund had a net asset value of $7.27 per share but the shares currently trade at $6.37 each. This gives the shares a 12.38% discount to the net asset value at the current price. This is a very reasonable price to pay for the fund, and it is in line with the 12.48% discount that the shares have traded at on average over the past month. Thus, the current price appears to be very reasonable for anyone looking to acquire or build a position.

Conclusion

In conclusion, investors are in desperate need of income to maintain their standard of living in today's highly inflationary environment. The Nuveen Preferred and Income Securities Fund offers investors a way to get some of this needed extra income without needing to work for it. The fund is unfortunately exposed to interest rate risk and the Federal Reserve has stated that interest rates will be raised twice over the remainder of the year. This will probably have a negative impact on the value of the fund's assets, which would push down the fund's share price. The current valuation appears to be pricing in some of this risk though as the shares are currently trading for much less than their intrinsic value. Overall, the fund might be worth considering as long as this risk is not a problem for you.

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