Favorite Market Weekly Review: Higher-Quality Yields Rise

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This article was first published to Systematic Income subscribers and free trials on January 30.

Welcome to another installment of our weekly preference market review where we discuss activity in the preferred bond and baby bond market both from the bottom up, highlighting individual news and events, as well as top to bottom, providing insight into the broader market. We also try to add historical context as well as relevant themes that seem to be driving the markets or that investors should be aware of. This update covers the period up to the fourth week of January.

Be sure to check out our other weekly updates covering BDC as well as CEF markets for insights across the entire revenue space.

Market Action

Preferred shares were down on the week along with most other income sectors. Preferred stocks are down around 2% for the month so far, putting the sector on track for the worst monthly return since March 2020. More generally, the sector’s decline is relatively muted compared to the CEF space which fell by more than 5%. away over the month.

Systematic income

Systematic income

So far, only one sector – energy – remains in the green. We remain overweight in the CEF and mREIT services sectors, which have outperformed in the current decline so far.

Systematic income

Systematic income

The recent rally in Treasury yields, equity prices and credit spreads means that many of the prices of higher quality preferred shares have fallen below “par”, which has pushed their yields up significantly. . Interestingly, longer-term yields, which tend to drive moves in higher-quality preferred stocks, performed oddly well despite sharp upward moves early in the yield curve. of the Treasury.

The preferred median net price of $25 trended lower in the second half of the year and is now only a little above $25.

Systematic income

Systematic income

While this stability in longer-term yields presents the risk that long-term yields will also begin to rise, the preferred stock sector has, in a sense, already pre-adjusted for this development, with better quality going up almost 2% as shown in the graph below.

Systematic income

Systematic income

Preferred stock investors need to consider two major risks: credit and duration. For many investors, neither is particularly attractive in the current environment. For these investors, higher quality fixed-to-float securities may be attractive, especially after the recent rise in yields.

A few worth highlighting are the Argo Group Preferred (ARGO.PA), trading at a yield of 5.7% with a 5-year Treasury yield +6.712% reset to 2025 if not not redeemed sooner (the company can redeem before the first call date at $26) and Series B SiriusPoint 8% (SPNT.PB), trading at a yield of 5.89% with a 5-year Treasury yield + 7.298% reset in 2026. The fixed/float coupon structure of these two securities means they will participate at higher rates if not traded. And because these stocks’ reset coupons (i.e. current 5-year Treasury yield + corresponding spread) are higher than their current fixed coupons (and the fact that both are trading above of “by”) suggests that both are quite likely to be repaid on the first call date, which limits their current sensitivity to interest rates.

Position and takeaways

In 2021, we increased the allocation to preferred shares (and BDCs) in our high-income portfolio, primarily at the expense of CEFs, while maintaining its return profile.

Systematic income

Systematic income

The recent draw, where CEFs underperformed both preferred stocks and BDCs, provides a good opportunity to consider a partial rotation into CEFs, especially when rebates hit double-digit levels. This highlights the ability of preferred stocks to provide both yield and ballast to an income portfolio.

In addition to considering potential rotation into CEFs from a more stable preference base, we rotate within securities of a given issuer, while increasing yield and often improving the duration. For example, we switched to the recently issued Eagle Point Credit Co. 5.375% 2029 (ECCV) Notes versus the 6.75% 2031 (ECCW) Notes which returned around 0.55% at worst. ECCV trades at a yield of 5.9%, has a maturity of 2029, an asset coverage of around 450% and also has strict asset coverage maintenance requirements that go beyond the requirements of the law. of 1940 on investment.

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