2023-12-28 10:49:09 ET
Summary
- PFFA is an actively-managed preferred stock ETF.
- The fund's strong, growing, fully-covered 9.7% yield is its key advantage, but it also comes with above-average risk and underperformed during the pandemic.
- An overview of the fund follows.
I last covered Virtus InfraCap U.S. Preferred Stock ETF ( PFFA ) in late 2022. In that article, I argued that PFFA's strong, fully-covered 8.8% yield made the fund a buy. The fund has performed reasonably well since, outperforming bond and preferred shares indexes, but with only 5.8% in total returns.
Since that article, PFFA's yield has risen to 9.7%, and market conditions have stabilized. In my opinion the fund remains a buy, and a somewhat stronger one than in the past.
PFFA - Overview and Analysis
Strategy and Holdings
PFFA is an actively-managed exchange-traded fund, or ETF, investing in U.S. preferred shares. These securities have characteristics of both equities and bonds but, in practice, behave like non-investment grade bonds or loans.
PFFA has moderate diversification, with investments in over 200 securities, and with exposure to most relevant industries. The fund is overweight real estate and real estate investment trusts, or REITs, however.
Concentration is quite high, with the fund's top ten holdings accounting for over 30% of its value.
As a comparison, the iShares Preferred and Income Securities ETF (PFF) invests in over 400 securities, with the top ten of these comprising 12% of its value. PFFA seems diversified enough , but definitely less than the average preferred shares index fund.
PFFA is a leveraged fund, with leverage in the 20% - 30% range. Leverage boosts income, returns, risk, volatility, and losses during downturns. In my opinion, PFFA's leverage is of a reasonable magnitude, and does not excessively boost risk.
Besides the above, not much else stands out about the fund's strategy or holdings.
Dividend Analysis
PFFA generates significant income, due to focusing on particularly high-yield preferred shares, and due to its leverage. The fund currently yields 9.7%, an incredibly strong yield on an absolute basis, and higher than most bonds and bond sub-asset classes.
It is also much higher than most preferred shares ETFs, including the five largest ones.
It is also higher than the closed-end fund, or CEF, preferred average of 8.0%, as per CEFConnect data. These tend to be leveraged too, and so are the most relevant comparison.
The fund's dividend growth track-record seems somewhere between adequate and poor. Dividends have decreased by almost 13% since inception, more than five years ago. Dividends were cut in early 2020, almost certainly due to the coronavirus pandemic. There have been no cuts since. On a more positive note, the fund has seen positive dividend growth since early 2021, due to higher Fed rates and improved economic conditions. Recent results seem more material, as economic conditions have significantly changed these past few years.
PFFA's dividends seem covered by underlying generation of income, as evidenced by the fund's 10.4% SEC yield. SEC yields are a standardized measure of a fund's expected returns, specifically excluding return of capital distributions and the like. Dividend yields should match SEC yields long term, so the fund should see positive dividend growth from here on out.
PFFA's strong 9.7% yield is the fund's key benefit and advantage relative to peers.
Risk Analysis
PFFA is a relatively risky fund, for several reasons
The fund focuses on preferred shares, a moderately risky asset class, and much riskier than the average bond or fixed-income securities.
PFFA further focuses on preferred shares with above-average yields, which almost certainly means above-average credit risk. I was unable to find credit ratings for the fund's portfolio, however.
The fund is actively-managed, so returns might differ from those of its index, and are dependent on the investment decisions taken by its management team.
PFFA is a leveraged fund, which straightforwardly boosts risks, volatility, and drawdowns.
Considering the above, investors should expect above-average losses during downturns and recessions. PFFA significantly underperformed during early 2020, the onset of the coronavirus pandemic, with a massive 70% drawdown. The fund recovered from some of these losses during the year, but not all.
Losses were incredibly high and, in all honesty, somewhat higher than expected for a fund with PFFA's characteristics. Specific investment decisions probably played a role.
In any case, PFFA is a relatively risky fund, a significant negative for shareholders.
Performance Analysis
PFFA's overall performance track-record is reasonably good, with the fund outperforming most bonds and bond sub-asset classes since inception, and for most relevant time periods. Of particular importance is the fact that the fund has achieved double the returns of high-yield corporate bond indexes, an asset class with broadly similar risk.
It has also outperformed its larger preferred peers, and by very wide margins.
On a more negative note, do remember that the fund is much riskier than average, and significantly underperformed during the last downturn. Said underperformance impacts the figures above too. The fund's 3Y returns look outstanding because it suffered a much larger drawdown in 2020, and so experienced a larger recovery after.
As a final point, PFFA's strong returns are due to its high yield and use of leverage. I believe that positioning has boosted recent returns too, as the fund was overweight energy when commodity prices were booming. Said position probably boosted losses in 2020 as well, however. Returns do not seem to be indicative of significant alpha, or the opposite.
Interest Rate Risk
Finally, a quick note on PFFA's interest rate risk.
Preferred shares can be fixed-rate or floating rate. Some, perhaps most, are fixed-to-floating, with a fixed rate for a couple of years, and a floating rate thereafter. These issues make it difficult to properly analyze the interest rate exposure of a preferred shares fund. In my experience, most tend to behave as fixed-rate, high-yield bond funds, with some interest rate risk. Although I was unable to find information about PFFA's interest rate risk or duration, the fund has seen similar losses to high-yield bond indexes since early 2022, when the Fed started to hike.
Considering the above, PFFA's interest rate risk exposure seems somewhat below average. I don't believe that this has important implications for shareholders, but still important to know.
Conclusion
Virtus InfraCap U.S. Preferred Stock ETF's strong, covered 9.7% dividend yield makes the fund a buy. The fund is riskier than average, and so might not be an appropriate investment for more risk-averse investors.
For further details see:
PFFA: Strong Preferred Stock ETF, Fully Covered 9.7% Yield