2024-01-16 07:38:34 ET
Summary
- Fixed to floating rate preferred stock have provided great returns over the last 16 months and will likely continue.
- There are yet double digit returns to be had in the next roughly 18 months.
- The PFFA ETF is a good option for securing those double digit returns.
Introduction:
The last roughly 16 months have provided investors with a once in a generation, and maybe once in a lifetime, opportunity to make high double digit returns investing in preferred stock and bonds. These two types of securities generally offer investors lower volatility and lower credit risk. While the Federal Reserve's ((FED)) aggressive increases in the Federal Funds Rate (FFR) and general tighter monetary policy did cause some negative impacts with market valuations of stocks and bonds, it also provided a fantastic investment opportunity in beaten down stock and bond valuations along the way.
I chose to focus much (not all) of my investment activity over the last 16 months on a relatively small niche of the preferred stock market. Starting in August, 2022, I began building a portfolio of Fixed-to-Floating ((FTF)) rate preferred securities and a couple of FtF Baby Bonds. The potential benefit of focusing on FtF securities becomes pretty clear once you consider that many of the FtF securities have a call/conversion date that falls during our current period of elevated interest rates.
With the Federal Open Market Committee ((FOMC)) having paused additional FFR rate increases for their last two meetings and included language in their latest post meeting press release, my holdings of FtF securities have started to increase in value. As those FtF securities approach their respective call/conversion dates, most and probably all, will tether to their $25 par value. This article gives a current summary of the performance of my (mostly) preferred stock portfolio and provides some additional FtF preferred stocks that I'm considering rolling into with proceeds from my current holdings.
Current Performance Summary:
The table below provides a summary of both current performance, current realized, and (mostly) unrealized capital gains, potential total capital gains, as well as the dividend yield I collect while holding these securities. To ensure readers have a clear understanding of the table values, the column descriptions/definitions are provided here.
- Buy Date - This column is the approximate middle of the accumulation period. For example, if I started accumulating on September 1, 2022 and stopped on November 30, 2022, the date reflected in this column is the approximate middle of that period (October 15, 2022). Some of these securities were accumulated via 10 - 20 individual transactions over several weeks or months. Providing the date of each individual transaction is not practical.
- Sell Date - Generally, this column will reflect the same mid range period for sale of the security. To date, I've only "sold" WFC.PR.D and not by my choice. Wells Fargo called and redeemed all the shares.
- Cost Basis - pretty straight forward. This is the share weighted average accumulation price I paid.
- Price - Friday, January 12, 2024 closing price.
- Current Gain - The difference between Friday's closing price and my Cost Basis divided by my Cost Basis.
- Potential Gain - The difference between $25 and my Cost Basis divided by my Cost Basis. Because I believe most, if not all, of the FtF securities will either be called/redeemed or will tether to their $25 par value after converting to a floating rate, this column should approximate the total gain I'll receive at disposition (called or sold).
- Yield - Current dividend yield or, in the case of WFC.PR.D, the yield at call/redemption.
Reader's should note a couple of points. If it is not obvious from the green highlight, every FTF security I hold is currently a realized ( WFC.PR.D ) or unrealized gain. Obviously, I'm please with the portfolio performance and I'm expecting to see many of those gains continue to grow over the next year as the FED begins lowering the FFR and these securities approach their respective call/conversion dates.
Those readers familiar with the two articles I published here and here , will note that I broadened my original list of FtF preferred stocks. In researching those potential investment securities listed in my previous publications, I determined there was generally higher potential returns to be gained with the FtF preferred stocks versus the Baby Bonds. I chose to narrow my Baby Bond list in favor of additional FtF preferred stock.
Readers should also note that my personal returns are different that those provided in my SA Analyst's Rating History (ET.PR.D Article Example). This is because almost all of my personal holdings were accumulated over time at varying prices versus the Analyst's Rating being a single point in time (date of article publication).
Returns Yet To Come:
While the performance for this FtF portfolio has been excellent to date, the issue of reinvestment risk looms front and center. If, as I expect, many of the FtF securities in my portfolio are called/redeemed, I'll want to redeploy those funds into productive investments. Energy Transfer has recently announced their plans to issue senior bonds to raise funds to, among other things, redeem their three floating rate preferred stock issues. I own two of the three so I'm already looking for suitable replacement securities.
It is not infrequent that I get comments posted along the lines of, your fixed income investment returns are sub-par compared to equities, S&P 500 index funds, or some other class of security. I have several portfolios in addition to this (mostly) preferred stock portfolio. I also have portfolios for individual stocks, individual traditional bonds, stock and bond ETFs, Baby Bonds, and Options. In other words, I maintain a diversified investment mix. I do not subscribe to a fixed allocation approach. I prefer to shift my allocation between investment classes based current economic and market conditions. The most recent interest rate cycle being a perfect example. I invested heavily in stocks with high sensitivity/volatility to interest rates over the last 16 months and allocated less money to growth, healthcare, and energy stocks. That approach is paying off very well as the FED moves to a more accommodating monetary policy. The bottom line in this paragraph is that I will redeploy funds from redeemed FtF preferred stock into whatever investment class I think will perform best over the coming quarters.
That said, since this article is focused on FtF preferred stock returns, I do have a short list of preferred stocks under consideration. The table below contains four preferred stocks that I already own, ACR.PR.C, MFA.PR.C, RITM.PR.C, and TWO.PR.C and four others that I may add to my portfolio depending on how quickly my current FtF holdings are called/redeemed and how quickly the FED loosens the reins on monetary policy. Readers should pay attention to the columns labeled Yield %, Years to Call, Yield to Call, and Reset Rate when evaluating the suitability of these FtF securities for investment. Too many investors focus on a singular metric (e.g. current yield or YTC) in making their decision.
In addition to the FtF preferred stocks in the table above, I will likely add to my holdings in the Virtus InfraCap US Preferred Stock ETF, ( PFFA ). I already have a large position in this ETF and it has performed well so far returning 13.1% plus a roughly 10% dividend during the period. There are a couple of reasons I believe PFFA will continue to perform over the coming quarters, one obvious and one not-so-obvious. It should be clear that bonds and bond like securities (i.e. PFFA) will continue to benefit from the FED implementing a looser monetary policy with a lower FFR and tapering off quantitative tightening. I believe it will take roughly 2 years for rates to "normalize". The price and total return of PFFA will rise as interest rates fall.
The less obvious reason for continued out performance I first wrote about in an SA article published June, 2023. In short, a large percentage of PFFA holdings are FtF preferred stocks that will convert to a higher floating rate over the next roughly 18 months. This means PFFA's dividend income will very likely rise over the next couple of years. I expect that we will see future increases in PFFA dividend distributions to holders of the ETF.
Finally, readers should note that PFFA does use leverage (borrowings) to boost investor returns. As interest rates fall, PFFA's leverage costs will also moderate though this is a fraction overall of PFFA's expense ratio. In other words, it will not have a significant impact on dividend distributions.
Conclusion:
The strategy of focusing my investments on FtF preferred stock and baby bonds as rising interest rates drove their prices down is providing outsized returns in an asset class with less volatility and less risk than the respective common stock shares. As interest rates continue to moderate, I expect my FtF portfolio holdings will continue to perform well providing solid double digit returns. The main risk I have going forward is reinvestment risk as the FtF securities are called/redeemed.
The eight FtF preferred stocks identified above are viable options for investing the proceeds from redeemed securities. The decision on which, if any, of those eight preferred stocks are added to my portfolio will depend on the current pricing, current yield, and potential total return (YTC). Additionally, I will likely deploy some of the reinvestment funds into PFFA as I expect PFFA to continue to provide outsized total returns as interest rates fall and PFFA's FtF holdings convert to floating rates.
Disclaimer: This article is not investment advice. This article is intended to provide my opinion to interested readers and to serve as a vehicle to generate informed discussion in the comment posting. I have no knowledge of individual investor circumstances, goals, portfolio concentration or diversification. Readers are strongly encouraged to complete their own due diligence on any stock, bond, fund or other investment vehicle mentioned in this article before investing.
For further details see:
Preferred Stock Double Digit Returns With PFFA