2023-07-12 12:44:21 ET
Summary
- PTA has recently released its semi-annual shareholder report and we take the opportunity to provide an update.
- PTA net income has fallen along with nearly all other credit CEFs. However, what GAAP income misses is the large contribution from its swap portfolio.
- PTA along with its sister fund LDP remains an attractive pair to rotate between, particularly for tax-sheltered investors.
In this article, we take another look at the Cohen & Steers Tax-Advantaged Preferred Securities and Income Fund ( PTA ). The fund has recently released its shareholder report, and we take this opportunity to update our analysis.
Despite all the noise around CoCos, high rates and regional banks, the fund's year-to-date return is a respectable +1.3%, outperforming the broader sector by over 5%. PTA trades at a 9.4% current yield and a 10% discount.
Quick Snapshot
PTA has a fairly typical allocation for a preferred CEF. Its portfolio is allocated mostly to institutional preferreds with about two-thirds of the portfolio allocated to financials like banks and insurance companies.
Its portfolio is about half in investment-grade stocks. It has a leverage of 37%.
Income Update
If we take a look at the fund's net income profile, we see that, on the face of it, the net income trajectory of the fund is not exactly inspiring. In fact, it's fallen by a quarter from the peak in early 2022.
The culprit is something we have discussed ad nauseam - rising leverage costs and, to a much smaller extent, deleveraging. As nearly all other leveraged funds, PTA has a floating-rate credit facility whose interest expense has grown which has caused net income to compress since 2022.
However, and this is the interesting bit, the fund also has a portfolio of interest rate swaps that nearly exactly offsets the rising interest expense.
The fact sheet states this fairly succinctly. Whereas nearly all leveraged CEFs are paying north of 6% on their leverage, PTA gets by with 1.5%.
The "magic" behind this is fairly straightforward and can be drawn on the back of a napkin. In short, PTA has a credit facility with State Street where it borrows around $560m for SOFR + 1% (red circle). It also has a portfolio of dollar swaps where it receives SOFR and pays 0.43% on a weighted-average basis (green circle). We can see that the SOFR flows cancel out and the 0.97% and 0.43% add up to a fixed cost of 1.4% on its leverage which covers 97% of the credit facility (we did not include the small GBP swap and facility portion in this illustration, but the math is very similar).
The reason we don't see the swap cash flows in net income is because, as off-balance sheet derivatives, swaps don't generate GAAP income. We can, however, see the value of the swaps portfolio in the shareholder report which was $54m, having increased from $11m in 2021 below.
The value of the swaps is simply the discounted total sum of the cash flows. We can put this in easier terms by dividing $54.2m by the 2.7-year weighted-average life of the swap portfolio and then dividing by net assets. What we get is the swaps portfolio generates an additional 1.9% of cash in the portfolio at current valuation.
Another attractive feature of the portfolio is that many preferreds are coming up to their reset date (highlighted in a portfolio extract below) where the coupon will either switch to a much higher (in nearly all cases) coupon or the stock will be redeemed. This is a win-win as a redemption will typically result in a small return boost and will allow the fund to reinvest the capital in a higher-coupon security, boosting net income (and likely portfolio yield as well if the return boost is significant).
Often it helps to get a top-down as well as bottom-up understanding of a fund's income profile. If we use a conservative figure of 7% for the fund's portfolio yield (Nuveen pegs the yield of the preferreds sector at 7.5%) then, once we go through the CEF income sausage factor below, we come out with a portfolio yield on price of 9.2% - fairly attractive in the current environment.
It's also important to highlight that PTA is the only fund in the sector that has managed a rise in its distribution over the past year. This is in the context of significant cuts in the rest of the sector (John Hancock funds have not made distribution cuts however their coverage remains sub-80%).
Rotation Strategy
We recently discussed our CEF pair rotation strategy in the context of a couple of high-yield corporate bond funds. However, because there are two other Cohen-managed preferred CEFs in the sector, this rotation strategy lends itself very well to this trio.
We used a lazy man's version of the strategy in our allocation, only making two rotations since the start of 2022 as the following chart shows.
The chart below shows the discount differential between LDP and PTA. It shows that PTA typically trades at a wider discount which is consistent with its higher management fee.
We held PTA through to April of this year when we rotated to LDP when it popped out to an unusually wider discount than PTA. We then moved back to PTA when the normal relationship resumed and PTA moved out to a wider discount.
The following chart shows the performance of the two funds and the rotation strategy. We can see that the strategy has outperformed by around 4% vs. the average of the two funds.
If we then compare the strategy against the broader preferreds sector we can see that it's the best-performing allocation since the first trade.
Overall we continue to like PTA here due to high preferreds yields and relatively wide high-single digit discounts. PTA does not look as attractive as it has in the past as the gap in its discount and the sector has narrowed quite a bit. With recent distribution cuts in LDP, we expect its discount to widen out which could offer another rotation opportunity from PTA.
For further details see:
PTA: Sticking With This 9.4% - Yielding CEF For Preferreds Exposure