PSK - PSK: Investment Grade Preferred Equity Fund

2023-05-03 15:38:05 ET

Summary

• PSK is an exchange-traded fund focused on preferred equity.
• The ETF tries to replicate the ICE Exchange-Listed Fixed & Adjustable Rate Preferred Securities Index.
• One of the Index requirements is around the existence of an investment-grade rating from either Moody's or S&P.
• PSK has a cross-sectoral build, and does not focus exclusively on banks.

Thesis

We all thought the regional banking crisis was solved with the First Republic Bank (FRC) resolution. It seems we were all wrong. The market is selling off violently today in the regional banking space, pushing all financial commentators to question the reasons behind this move:

For those who have not been through the 2008-2009 market, this is how a banking crisis looks. The general idea here is that a crisis does not get resolved by another bank takeover, but by curing what is ailing the sector in the first place. And unfortunately the reasons behind the crisis are multiple: higher rates, lack of confidence, poor risk management, poor asset/liability management and a lack of access to fresh, cheap capital.

The market always probes for the weakest in the herd. The FRC failure did not solve any issue, it just made market participants ask themselves what is the next shoe to drop. As we can see from the above table the market takes no prisoners, with the common shares of many regional banks down in the double digits.

One of the key lessons from this crisis is that the '2023 Bank Runs' take no prisoners - all of the investor capital is wiped out in a restructuring. That includes common equity, preferred stock and senior bonds. This lesson is currently reverberating through various markets. You now have bond managers hedging their regional banks bond holdings via CDS protection and put options on the common stock (given the liquidity present in the equity market). This negative feedback loop is causing today's action in our mind.

With pain comes opportunity, and we are firmly in the camp that thinks today's environment is a great one to start looking at financials preferred equity funds. We are not fans of the common equity in the bank space for many reasons. We do think that a well-diversified preferred equity portfolio will be able to capture the much wider spreads and current distressed situations. Preferred equity just needs the bank to survive. Not be profitable or grow.

The SPDR ICE Preferred Securities ETF (PSK) is another instrument in this space. The vehicle aggregates both variable as well as fixed rate preferred securities. The fund has a cross-sector reach, not being exclusively catered towards financial services names. As per its literature:

The SPDR ICE Preferred Securities ETF seeks to provide investment results that, before fees and expenses, correspond generally to the total return performance of the ICE Exchange-Listed Fixed & Adjustable Rate Preferred Securities Index (the "Index")

The Index holdings are required to be rated investment grade by either Moody's Investors Service, Inc. or Standard & Poor's Financial Services, LLC.

The holdings might hold split ratings (i.e. a different rating by Moody's/S&P) but they will be investment grade by at least one agency.

This fund is not a buy and hold vehicle. The ETF has a mediocre long term performance (5-year lookback), and its analytics support the poor risk/reward profile via a high standard deviation and negative Sharpe ratio. This fund is only a cyclical play on lower rates, but it lacks when compared to its peers.

Analytics

• AUM: $1 billion
• Sharpe Ratio: -0.12 (3Y).
• Std. Deviation: 13.3 (3Y).
• Yield: 6.22%
• Premium/Discount to NAV: n/a
• Z-Stat: n/a
• Leverage Ratio: 0%
• Composition: Fixed Income - Preferred Shares Financials
• Duration: n/a
• Expense Ratio: 0.45%

Holdings

Financials are two thirds of this ETF, but the fund is a cross-sectoral one:

AT&T (T), one of top holdings in this ETF, does not fall in the financial services sector:

Performance

The fund is in line with its peers on a 1-year time-frame:

On a long-term basis (5-years), the fund is at the bottom of the cohort from a performance stand-point:

The difference is very significant here in terms of absolute total return provided by the best and worst names in the analyzed cohort.

Conclusion

PSK is an exchange traded fund focused on preferred equity. The vehicle invests in both variable rate and fixed rate instruments. The fund take cross-sectoral positions, and follows the ICE Exchange-Listed Fixed & Adjustable Rate Preferred Securities Index . One of the index requirements is centered around an investment grade rating by either of the rating agencies. This ETF is not a proper buy-and-hold vehicle. The fund has poor analytics and a mediocre long term performance. The best way to trade PSK is as a cyclical rates play. The fund should have a solid 2024, given the expectations for lower rates (as implied by the SOFR curve), but we have covered much better funds in the preferred space. A retail investor should look at the iShares Preferred and Income Securities ETF ( PFF ) covered here , and the Invesco Variable Rate Preferred ETF ( VRP ) which we covered here .

For further details see: