Preferreds of Closed End Funds Offer Safety – and Tantalizing Yields

Listing of closed end fund preferreds

In 2011 I wrote a short article on Seeking Alpha about preferred stock offered by closed end funds (CEF’s)—and I have loved CEF preferreds ever since that time.

What’s interesting about the article I mention above is that the 10 year treasury was trading at about the same level as today–but pricing on CEF preferreds were much stronger. The prime difference is rates were falling in 2011 and they are rising in 2022.

Today we are reaching a point where the current yields on many of the CEF preferreds are providing tantalizing dividend returns, in particular for those that are ‘immediate income’ (want a current income stream with less regard for share price erosion) investors and desire lots of safety.

I wanted to take a moment to review some of the CEF preferred issues and a few that are ‘term preferreds’ in particular.

At this moment there are 9 issues of CEF preferreds that are term preferreds–7 that are issued by CLO owner Priority Income Fund (not publicly traded) – these shares are unrated by the major ratings company’s. There is 1 issue outstanding from RiverNorth Specialty Finance with a 5.875% coupon (RMPL-) and 1 issue from XAI Octagon Floating Rate and Alternative Income Term Trust with a juicy coupon of 6.50% (XFLT-A)–neither of these issues are rated.

Disclosure–I own 2 issues of Priority Income Fund term preferreds and also the XFLT-A issue. I plan to purchase shares in RMPL- next week.

As you all know CEF’s are required to maintain asset coverage ratios of at least 200%–meaning they must hold securities that are worth at least twice the value of their ‘senior securities’ (preferreds and debt)–the higher the asset coverage ratio the safer the senior security.

An extreme example of asset coverage ratios would be the 5.00% perpetual preferred issue outstanding from CEF Tri-Continental (TY-P). This issue has been outstanding since 1963 and is a $50/share issue redeemable at $55/share anytime. The preferred issue is small, but there is an asset coverage ratio of 5300%—that spells safety. On the other hand like all perpetuals the share price can move sharply lower with rising interest rates–it traded as low as $18/share in 1981–but just the same the safety aspect was extremely strong.

Disclosure–I own a small TY-P position.

Next to Tri-Continental the Gabelli CEF’s have some of the strongest asset coverage ratios–from 260% to 952%. Unfortunately, for me, the Gabelli preferreds, have current yields a bit too low–in the 5.50% area and are all perpetuals meaning they may have more downside. Here again, if you are looking for super safety, some nibbles here might be appropriate with more purchases if prices fall more.

So back to the 2 term preferred issues I like the most right now–the term preferreds from 5.875% RiverNorth Specialty Finance (RMPL-) and XAI Octagon 6.50% (XFLT-A).

Both of these issues were holding well above $25 until just recently when their prices began to erode. RMPL- fell to $25.03 on Friday which makes it much more desirable than when the price was at $25.80 a month ago. The RiverNorth issue has a mandatory redemption on 10/31/2024–just 2.5 years away. While the CEF is not very well managed as an investor in the senior security I care mainly that they remain solvent and this will likely not be a problem (obviously no guarantees). The CEF has a current asset coverage ratio of 286% (as of 12/31/2021). At a current yield of 5.87% with essentially the same yield to maturity it is worth at least a 50% position for me. I will buy this next week assuming the share price remains around $25.03 or maybe a couple cents lower.

I like the 6.50% XAI Octagon Floating Rate and Alternative Income Term Trust (XFLT-A) and own a decent sized position right now (550 shares). It is my intention to buy more when I can get it at a slightly lower price than where it currently trades—$25.37. This is a current yield of 6.43%–BUT the yield to worst is under 5%, which makes this a little dicier–the 1st optional redemption date is 3/31/2023–less than a year away. My current assumption is the CEF will NOT call these early and they will run to maturity on 3/31/2026. Note that XFLT is a term trust and will be liquidated in 2029. I note that about 40% of assets are CLO equity–10% CLO debt and 41% of assets are senior secured 1st lien loans.

How will I buy these? I will put in good-til-cancelled orders. I am looking to buy the XFLT-A shares at around $25.20-$25.25. The RiverNorth shares I will try to buy right around $25–just below where they currently are trading. It should go without saying that if these issues fall below $25 the yield to maturity will rise and they will become very desirable buys.

As always this is not a recommendation for anyone to buy these issues–it is just what I am doing. Every single one of use has different needs and risk tolerances. Everyone should do all of their own due diligence if considering a purchase. You can access all SEC filings for all companies and issues mentioned here by going to the individual security links or from any spreadsheet which will take you to individual prospectuses or to the SEC page with all company filings.

23 thoughts on “Preferreds of Closed End Funds Offer Safety – and Tantalizing Yields”

  1. Wonderful article Tim. I appreciate your thinking on threading the needle on risk with preferreds in this market. It’s fascinating to see how skilled investors play defense in this market.
    Unlike many of you on this site, I don’t have the skill set to do deep dives into company financial statements.
    While I may be “fighting the last war,” i.e. 2008-9; when I feel liquidity tightening up in junk debt it rings like a “Katie, bar the gate” moment.” Of course, I may be mistaken as I frequently am.
    So CREDIT RISK becomes my main navigator. I’ve taken losses on all my non-rated/sub-IG preferreds with the exception of NRZ-D, AGNCO, RILYZ, and UPB-H. I’m not as much concerned about where the price is, as I am that the company will be standing through some potentially tough years ahead. I’m happy with the income from the 30 or so preferred positions regardless of where the price goes, and have even added cautiously as the prices drop.
    Rather than taking risk on CLO preferreds whose security backstops I can’t evaluate, I would rather take a lesser risk in the senior debt market, and buy short-term split IG/sub-IG or even sub-IG known companies to get that added yield. Here are a couple recent buys and thinking:
    –Ecopetrol SA (09/18/23) 4.39% YTM BB+/Baa3. Rationale: short-term; Columbia’s largest petrol company, current petrol shortage crisis.
    –Occidental Pete Corp (07/01/24) 4.419% YTM; Ba1/BB+. Rationale: short-term; Buffet buying more of it; we’re in a petrol shortage crisis. Bought this Friday at market close.
    MPLX, Royal Bank Scotland, Lennar, Boeing have some 4-4.5% offerings with ’24 or ’25 maturities.
    Again, I view these holdings as cash placeholders, and inflation is largely tangential as my kids are grown up, I drive an electric car, I eat out way less given Covid/favorite restaurants having closed.
    The key to being a good investor is defense. Any sensible person can make money in good times, but it’s how we manage the drastic bear markets that separate the wise investors. Good luck to all.

  2. fwiw, some of the Gabelli preferreds have both puts dates (both at the fund option and investor option) and set termination dates. See the press releases on their website for details, such as:

    “The Series C Preferred Shares, which trade on the New York Stock Exchange under the symbol “GDL Pr C”, were issued on March 26, 2018 at $50.00 per share. The Series C Preferred pay distributions quarterly at an annualized dividend rate of 4.00% of the $50.00 per share liquidation preference of the Series C Preferred for all remaining quarterly dividend periods prior to the mandatory redemption date for the Series C Preferred of March 26, 2025. The dividend rate is determined by the Fund’s Board of Trustees or a committee thereof in its sole discretion, and such rate will be not less than an annualized rate of 4.00% and not greater than an annualized rate of 6.00%, pursuant to the provisions of the Statement of Preferences for the Series C Preferred. The Series C Preferred may be put back to the Fund during the 30-day period prior to March 26, 2022 at the liquidation preference of $50.00 per share, plus any accumulated and unpaid dividends, and redeemed by the Fund, at its option, at the liquidation preference of $50.00 per share, plus any accumulated and unpaid dividends, on March 26, 2023.”

  3. I’m amazed RMPL-PR wasn’t called a while back when they could have refinanced at an attractive rate. Would still be surprised of they wait until less than 12 months out to roll it.

    I’m a little skeptical of the CLO CEFs here. When I analyze mREIT and BDC safety I generally assume the CLO equity will be worthless in a deep recession. Still, I think the bonds are okay as CEFs will dilute and delever as needed to survive.

  4. I have held RMPLPR for couple years now,,,just now it has come back to 25 level,,,will buy more monday as i view it as a good cash alternative….solid term i prefer over cumulative perpetuals

  5. I own four Closed End Funds and have had a less then satisfying experience in terms of share price. Though only one them is a CEF Preferred offering. The other three are are all Blackrock CEFs, BHK, BST and BMEZ. and my one Preferred CEF is PCEF.
    No complaints on the monthly distributions but the share prices have been pummeled in the same way as IG Preferreds.
    Given that it was more of an experiment to try out CEFs which I started in Nov 2021 I’m not overly concerned but frankly I wish I had that money to put into more stable IG Corporate Bonds at 4% right now

    1. you may already know this, but just in case – the main article speaks to preferreds for specific closed end funds, not closed end funds that hold preferred stocks. These are entirely different animals and you don’t want to confuse them. Plus, PCEF is actually an ETF, which usually means it will trade more or less pretty close to the actual NAV.

      CEFs such as the ones you own on the other hand can trade for wide discounts or premiums as you can see on website like https://www.cefconnect.com/Default.aspx which means they can trade well above or below their actual NAVs. BST, for example, had a 52 week range of 11.94% premium above NAV and a 7.48% discount to NAV. The movement above and below NAV can play havoc on your returns (because your return is tied to the market price, which is NOT NAV), especially during volatile markets.

      The last comprehensive book on closed end funds was written in 1991, but you might want to research this topic futher as there are a few wrinkles to grasp before trying to maximize returns. Just flipping thru the Blackrock website, there is a section on CEFs and a (presumably) free newsletter here:

      https://www.blackrock.com/us/individual/education/closed-end-funds

      If all of this is obvious, please disregard this note.

      1. I will second this and make one further point: Most fixed income closed end funds use leverage, and a lot of it … That’s going to massively amplify both the move in the nav AND the discount. Watch out at year end as well, lots of tax loss selling likely in Oct and Nov (but, might be dampened by the fact that nobody has any realized gains to offset!).

    2. Yes Richard–I am not a CEF fan–(common shares)–preferreds are a different story.

  6. interesting , I always considered 5.00% “my number”for something safe? not as greedy as some here, at 74 5.00% takes me to the house.

    1. Mike–I thought 5% for safety also–but now I have moved my goal higher with rising rates inflation.

      1. Safe is a nebulous term in concert with the timing of that view. Im certainly glad I didnt view 5% as safe, or I would be looking at 20% plus capital losses from past YTD alone from that viewpoint if I had viewed 5% preferreds as safe. Adjusting to market forces was/is necessary if mark to market capital preservation is important to ones goals.
        Term dated RMPL- has been an alluring one for me the past year or so. It caved to near par from a 10k dump around market close Thursday and has stayed pinned around $25 on Friday. I bought a couple hundred more myself.

        1. Grid,
          You mention you would be looking at 20%+ losses YTD if you had 5% preferreds. Do you have an estimate what your YTD losses would be if you had 6% preferreds. Or 7%?

          1. It gets dicier with those because more factors come into play such as past call status and credit quality. But if one had been in the 6-8% decent quality past call, call anchored issues many of us had advocated “hiding out in”, along with short rope duration plays there really wouldnt be much of a loss. Issues like MER-K and the STAR and Safe Bulker preferreds for example are all net positive last 12 months allowing for divi payment. These were the places to be.
            Different cycles provide better places to go. Credit spreads, economic cycles, etc. also factor in.
            Personally Im not as confident on the next cycle. If rates move forward or credit spreads move wider for example, the above could feel the heat more.
            I continue to prune or find short duration. For example, I just bought today 300 shares of APRDN at $104 to collect the $1 plus long stub for a 6 week call induced hold.

            1. Somebody gifted me some shares of APRDM at $103.25 this morning. I was slow kicking up the bid so I didn’t get any after that.

          2. dd as the guy with that 5%opinion my prefferreds are down a total 9.8% from
            cost not year to date. an currently yield over 5.5% avg. the principal may or may not return but I SWAN.

          3. DD, here are the stats you asked for. I started with all preferreds regardless of par value.
            Had to trade on 12/31/21
            Had to trade so far today on 5/16/22
            Remove convertibles
            Remove issues that were not >=$10 on 12/31/21
            Remove issues that I show are NOT currently paying dividends
            Used the EXACT coupon yield, so did NOT include any “close by” yields

            Coupon yield, year to date price change NOT including dividends paid

            4.0 -30.2%
            5.0 -15.5%
            6.0 -7.6%
            7.0 -9.3%
            8.0 -4.3%
            9.0 -11.3%

            Small sample size but I think it tells us two things:

            1) Bond math works i.e. low coupon issues fall a lot more than high coupon issues, all things being equal

            2) Some of the junkiest, highest risk, aka highest coupon issues are suffering because of non-payment risk

            1. Tex,
              Thank you. Very interesting! Indeed, generally it confirms math and risk on junkiest. The 9.3% though may be harder to rationalise and the 4.3% kind of surprised me a bit. Of course separating term from perpetuals would probably draw a clearer picture? So our question now is: how will this look after another 1 or 2% in fed rates.

              1. DD, I have the same data on terms/babys but did not post it because it is convoluted. A term maturing in 2 years is a very different creature than one maturing in 75 years. I would argue the 75 year issue is about the same as regular preferred, so data on very long maturity issues would be interesting to see. If it is a baby, it is higher on the debt stack than a preferred, but looking 75 years out, I am not sure it makes much difference in general.

                As for how these preferreds will looks after another 1% or 2% Fed rate hikes, I am broken record. For all of 2022 to date, my personal highest probability forecast is for lower preferred prices in general. Obviously excepting special situations like likely to be called, illiquids (Aka Grid’s”) etc. I still think cash with its <.5% yield will outperform preferreds. Obviously I might be 100% wrong and TODAY is the bottom.

                1. Tex, you could be 100% correct. All I know is I have slipped below a 2% gain this year, and if I had shared your viewpoint Jan. 1, I could have just been in cash this entire time and focused on my sports betting which has been a lot more profitable return percentage wise than this has.
                  One thing is largely sure, the long end will turn positive before the short end is 100% complete. But that doesnt help time the end either as no one knows the latter. I think we are going to take our IBond gifting from 10k to 15k this year, so that gets me $40k in these since last Sept. Not an insignificant amount for me and better yield than cash. The way I see the energy landscape and food, Im not taking on too much opportunity risk, unwinding the gift segments out to 2024. The 30k Alabama Power hideout will be a short duration safe zone too (A special shout out to New To This 2015 for the info).
                  Still have plenty of cash sitting too as it doesnt really have a home to hide. And unfortunately unless a deeper sellout occurs in 2 months or so, Im going to have even more cash dumped back in my lap that I will have to stay disciplined on.

Leave a Reply

Your email address will not be published.