Preferred Shares With International Exposure And 9% Yield
Summary Preferred shares as an investment category is dominated by US securities. Two funds offer opportunities to diversify the preferred shares allocation in an income portfolio. These funds are discussed here. With this article, I conclude my look at preferred-shares closed-end funds. In the first ( Where Are the Best Opportunities in Preferred Shares? ), I presented the data on 16 funds in the category. I followed up with a closer look at my choices among the purely domestic fund ( These Top Choices for Preferred Shares Will Bring Nearly 9% Yields to Your Income Portfolio ). Here, I conclude with the two international funds in the category. The Funds Flaherty & Crumrine Dynamic Preferred & Income Fund Inc (NYSE: DFP ) First Trust Intermediate Duration Preferred & Income Fund (NYSE: FPF ) Both funds score high enough on my initial screen to make it to the overall short list. DFP stood out on the basis of its recent returns (especially on NAV) and FPF scored high for its high distribution (top of the category for market distribution, and second on NAV) and its high level (third in category) of undistributed net investment income backing up the distribution yields. I put off examining them in detail because I wanted to focus on the domestic funds, all of which had an extended historical record. DFP and FPF are more recent funds; both, coincidentally, have the same inception date of May 24, 2013. Discount/Premium Discounts are identical (-7.95%) for each, which is about mid-range for the category. And for both, the discounts have been shrinking. DFP’s Z-scores are positive for 3 and 6 months. For 3 months it’s 1.03. For FPF, Z-scores are positive for 3, 6, and 12 months; for 3 months it’s 1.1. Both funds showed a similar pattern in the evolution of their discounts. Both held a premium valuation at inception and soon thereafter, then, as is typical of closed-end funds, the premiums fell to discounts as the fund began trading. This can be seen in these charts (from cefconnect ) of their full premium/discount histories. First DFP (click to enlarge) and FPF. (click to enlarge) FPF falls below the category trend line on the Discount vs. NAV Distribution chart (see previous articles for this chart). DFP is above it. As I’ve noted, this relationship favors funds that fall below the trend line. Distributions FPF’s yield on price is a category-leading 9.01%, from a 8.29% NAV distribution yield. DFP’s distributions are mid-category, both on price (8.59%) and NAV (7.91%). DFP has negative UNII (undistributed net investment income) at -2.5% of its distribution, which value places it ahead of only two other funds, neither of which made the cut for the short list. FPF is positive with excess UNII at 5.28% of its distribution, which is third for the metric in the category Two funds examined previously, JPC and HPI , lead. FPF has paid out special distributions in each of its two years of activity; it would appear shareholders can expect another for 2015. When the special distribution is included in yield calculations, FPF’s yield for the past twelve months is 9.8%. Preferred shares dividends may be qualified for the 15% tax rate for most investors. For the 2014 tax year, FPF reported 56.53% of its income from qualified dividends, and DFP reported 70.20%. This is similar to the pattern we saw previously in the domestic funds where the Flaherty & Crumrine funds had the highest levels of qualified dividends. Portfolios These two are the only funds in the category that have holdings extending beyond US borders. All of the others are 100% invested in US companies. For DFP, the non-US segment of the portfolio is 21.3%; for FPF it is more than twice that, 48.7%. FPF also has a more diverse group of countries represented as we see in the tables below: (click to enlarge) Both funds are leveraged, as are all the funds in this category. DFP has 33.6% leverage, which is the category median, and FPF has 30.99% ranking seventh or one off the median. DFP’s portfolio is 97.8% invested in preferred shares. FPF’s objective strategy statement ( here ) states that it “will invest at least 80% of its Managed Assets in a portfolio of preferred and other income-producing securities.” The fund is listed as having 29.8% of its portfolio in preferreds and 67.3% is in a category described as “investment funds.” From the most recent holdings statement, I take that larger category to be fixed-rate capital preferred securities, hybrid securities that combine the features of both corporate bonds and preferred stock. These are typically issued by utility companies and financial institutions and accrue certain tax benefits to the issuing institution. According to Fidelity, these typically provide higher yields and typically are senior to preferred or common stock. Morningstar lists a weighted average credit score of BBB- for DFP. No average is calculated for FPF, but the fund’s most recent report ( here ) shows a distribution centered on BBB-. FPF’s credit quality distribution is shown below: (click to enlarge) Both funds’ portfolios are heavily concentrated in the financial sector. This is how FPF reports the industry distribution for its holdings: (click to enlarge) And this is how DFP’s holdings break down on a sector level: Summary These funds offer international diversification to the preferred shares investor. FPF, with its greater exposure to non-US holdings and a wider range of countries in its portfolio, does this more effectively. The primary reason to venture into these funds, in my view, is for international exposure and FPF does that more effectively than DFP. So, the edge here goes to FPF. Both have a reasonable discount, but those discounts are well above (i.e., less negative, therefore less discounted) recent mean values. Neither has an edge on this metric. DPF offers a high yield, but it comes with the downside of negative UNII. FPF’s yield is higher and one might reasonably expect a year-end special distribution from the fund as well. FPF has a stronger recent total return record (11.5% for one year, second to the John Hancock funds ( HPF , HPI and HPS discussed earlier). A clear win for FPF here. I’m not sure that I’d consider either fund a timely buy right now, but between the two, the clear choice would have to be FPF for its stronger yield, favorable UNII, and its more diverse portfolio.