Sell/Short iShares Preferred ETF (PFF) And These Overvalued Preferred Stocks

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The fixed-income market is currently very expensive and it is time to be defensive.iShares Preferred ETF is a very poor ETF that offers a great place to get insurance against a sell off in fixed-...

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I will explain why.Additionally, I point out several overvalued preferred stocks (some owned by PFF and some not).These overvalued preferred stocks include symbols FTAIO, OCCIO, PRIF-K, PEB-F, HTFB (actually a baby bond) and MAA-I.   tobiasjo  At our service, we focus on relative valuation, which points us to the best and worst securities to own in the fixed-income space. Normally, I write about very undervalued securities, but today I am highlighting some of the worst preferred stocks to own. But before we get into some specific names, I want to focus on the main theme of this article, which is about the overvalued fixed-income market and the large fixed-income ETF with the symbol PFF (NASDAQ:PFF). Prices used are the closing prices from 10/25/2024 The Overvalued Fixed-Income Market Although we are still able to find some good values in this market, they have become difficult to come by. The yield spread between corporate securities and treasuries has become historically quite tight. In other words, you are not getting paid much extra yield for buying more risky preferred stocks and bonds than what you are getting from treasuries. While historically the yield spread between BB rated bonds and treasuries is between 1.5% and 5%, currently the spread is only around 1.85%, near historic lows. And when we are in periods of financial turmoil, the spread can rise to 8%. So there is a lot of risk owning fixed-income, as there would seem to be a lot more price downside than upside. And at the same time, geopolitical risks are unusually high for spreads to be so narrow, at least in my opinion. But the market is not homogenous. There are egregiously overvalued preferred stocks as well as some still undervalued preferred stocks. This provides for opportunity. Currently, I am long the undervalued preferred stocks and short some individual preferred stocks and short a good amount of symbol PFF. PFF – iShares Preferred & Income Securities ETF PFF (PFF) is a very poorly structured and operated ETF. It simply follows an index which basically buys almost any preferred stock or baby bond that has a market capitalization of $100 million or more. Because smaller cap preferred stocks tend to be the best values and highest yielders, PFF is missing out on the best values. So PFF holders are losers right off the bat. Here are some other reasons/examples that show why PFF is a losing proposition. PFF has no smarts or active management. An SA friend of mine tells the story of how when Ladenberg Thalmann (LTS) was bought out by a weak company, and announced that they were going to delist their baby bonds and preferred stock. PFF owned their preferred stock. Fortunately, the preferred stock had a provision that the preferred shares could be sold back to the company at $25 on a change of control, and most holders of this LTS preferred stock naturally sold their shares back to the company. But PFF, which knows nothing about the securities they hold, did not and watched their preferred stock drop all the way to $10 when it was delisted. 2. PFF simply follows an index and when the index changes PFF must adjust its holdings by buying and/or selling shares to match the index. Given that they hold large amounts of securities in a relatively illiquid market, PFF buying and selling causes large moves in the price, and they get terrible prices when they buy and sell, which harms their returns. And to make matters worse, they seem to do a large part of their buying and selling at the end of the trading day on the last day of each month. And this dumping or buying large volumes of particular preferred stocks or baby bonds all at once gets them terrible prices. Here is an example of what happened when PFF was forced to buy EPR-G in August because of a change in the index that they follow. And there are very many examples of this, and many even worse. EPR-G Price Chart Etrade I can’t prove that the buying in the last couple of weeks of August was mostly attributed to PFF buying, but you can see the price of EPR-G went from around $20.60 to $23.00 in 2.5 weeks. But the huge spike in price from $22.00 to $23.00 on huge volume on the last trading day of the month is a sure sign that the buying on this day was by PFF. So you can see how much PFF overpaid versus what an individual would have paid before PFF started buying. When PFF buys at prices that are 2% or 3% above the going price and then the same thing happens when it sells, how can they possibly match what an intelligent and experienced individual investor can earn. 3. PFF claims a yield of around 6%. However, it ignores yield to call (YTC) which overstates the real yield. For example, PFF owns WCC-A. It has a current yield of 10.36%. But it is virtually certain to be called in 9 months, generating a YTC of only 5.7%. And they own a number of preferred stocks that sell way over par whose current yields appear good, but their YTCs are quite low. So this 6% current yield is really an overstatement of the kind of yield you can expect from PFF. 4. PFF holds some of the most overvalued preferred stocks with low yields. Many bank preferred stocks as well as some REIT preferred stocks that PFF owns are trading near 5% now. As perpetual preferred stocks, you want to look at the spread between preferred stocks and 30 year treasuries. Currently, the 30-year treasury yields 4.5%. So the spread over treasuries is extremely narrow. A more detailed article on this situation can be read by those interested. In the current interest rate environment, these preferred stocks would seem to have a lot more price downside than upside. Shorting PFF Is Very Cheap Insurance Because the market is historically quite overvalued, but I like my undervalued positions, by shorting PFF I can take oversized positions in preferred stocks and baby bonds that, I think, have great potential while mitigating against a big market selloff that could move them lower in price. As someone who has traded/invested in fixed-income for decades, greatly outperforming PFF by picking individual securities is actually quite easy for the reasons stated above. While I tend to generate total returns averaging in the high teens, PFF’s 6% yield, which is overstated due to the failure to account for low YTCs, is cheap insurance. And it is even much cheaper than it appears in certain circumstances, as I will explain in the next paragraph. I short PFF at Interactive Brokers (IBKR). The borrowing cost to short is currently .75%, but I am earning interest on the money I receive from shorting PFF. This may not work as well for those with small accounts, but all of the money that you receive from shorting that is over $100,000 earns you 3.58% and money received for shorting over $1 million earns you 4.33%. Thus, if I am receiving 4% on the money earned from shorting PFF and paying only a .75% to short PFF, I am actually getting paid 3.25% for shorting PFF. Of course, I must also pay the 6% PFF dividend, so the net cost for me is 2.75%. But when you consider that the 6% is really overstated and the ridiculous operation of PFF where they hold very overvalued stocks and buy and sell at exorbitant prices due buying/selling large quantities of preferred stocks and baby bonds all at once, PFF is close to free insurance. And that doesn't include the fact that my longs earn a much higher yield than my PFF shorts. So shorting PFF in order to raise cash to buy higher yielding fixed-income securities makes complete sense. So you can invest in more long positions than you might normally feel comfortable with due to having a short position in PFF. I tend to achieve total returns of around 17% annually, so this is a no-brainer for me. As an aside, at my Etrade broker I can short PFF with no shorting fees, but I don't earn interest on the cash received from the short sale. So this is not as good. So in this situation it is basically a pairs trade - long the securities you like and short PFF. This trade should still be a winner, and you are aided by receiving a higher yield on your longs than you are paying on your PFF short. The large number of mispricings in the market make going long and short quite attractive at the moment and here are some examples of very overvalued preferred stocks and a baby bond. Sell FTAIO FTAIO (FTAIO) becomes callable in 6.5 weeks at $25.00, yet it currently sells for $26.30. PFF owns this preferred stock because they have no choice. It is in the index that they must follow. Considering that its sister preferred stock (FTAIP) was just called shortly after it started to float, there is a very high likelihood that FTAIO will also be called with a very negative YTC. At $25.00, FTAIO will float at 11.5%. FTAI is making tons of money, the common stock has been a huge performer, and the risk of a call of FTAIO is very high given that similar FTAIP was called and FTAI can certainly get financing at much lower rates than 11.5%. Their bonds yield around 6%. So FTAIO is a strong sell. Sell PEB-F (and buy RLJ-A) PEB-F (PEB.PR.F) is also held by PFF and is one of the worst preferred stock values in the hotel REIT preferred space. At a price of $23.47 it has the lowest current yield of the 4 PEB preferred stocks yet the least discount to par or the least price upside. PEB-H has $2.70 more upside and a higher current yield to boot. But to make it worse, PEB preferred stocks in general are overvalued relative to hotel REIT preferred stock RLJ-A (RLJ.PR.A). PEB-F has a current yield of 6.74% while RLJ-A has a 7.64% yield. And RLJ has a much better balance sheet – lower leverage and a massive cash holding – as well as the fact that RLJ-A cannot be called. So its price upside potential is much greater than PEB-F’s price upside. While PEB-F is about $1.75 below its all-time high, RLJ-A is $3.50 below its all-time high. Sell MAA-I MAA-I (MAA.PR.I) is callable at $50 in less than 2 years but sells for $58.54. This is an example where investors seem to focus on their current yield without realizing that the YTC is zero. And with MAA being a very strong investment grade REIT preferred stock, and with other strong REIT preferreds trading at yields of around 5.5%, it is a virtual certainty that MAA-I will be called given its 8.5% coupon. If you want to earning nothing over the next 2 years, hold onto MAA-I. Sell OCCIO OCCI is a CEF (closed end fund) that owns CLO equity tranches, so it is similar to ECC, PRIF and OXLC. OCCIO (OCCIO) is a term preferred stock issued by OCCI which matures in April 2026. However, at a price of $24.84 its YTM is only 6.5% while other term preferred stocks in the same sector have YTMs of closer to 8% and even higher. Even its sister term preferred stock, OCCIN, has a YTM of 7.95%, and it also matures in 2026 but at the end of the year. OXLCP, which matures just 10 months later than OCCIO, has an 8.22% YTM. And PRIF-G, which matures fairly close to when OCCIO matures, has an 8.18% YTM. So selling OCCIO and picking up one of the much better term preferreds from the same sector makes loads of sense. You can even get a bond, OXLCI, from the same sector with over an 8% YTM. Sell HTFB HTFB (HTFB) is a baby bond from a BDC called Horizon Technology (HRZN) which has 58% leverage. At a price of $24.64 it has a 6.14% YTM. That is extremely low for a BDC baby bond. Its sister bond from the same company, HTFC, has a much higher yield of 7.86%. So why own HTFB? A baby bond with lower leverage than HRZN, symbol RWAYZ, has a YTM of 7.88% and RWAYL a YTM of 7.64%, both greatly better than the 6.14% YTM from HTFB. Sell PRIF-K & Buy ECC-D and Sell OXLCL & Buy OXLCI These are very mispriced situations. For more detail on using relative valuation to greatly outperform the market, and for specifics on ECC-D, PRIF-K (PRIF.PR.K), OXLCI and OXLCL, you can read my recent article here. Believe it or not, you can greatly outperform common stocks with an actively managed fixed-income portfolio with much less risk. Summary In this article, I point out that fixed-income securities are very richly priced historically. The yield spread over treasuries is now quite narrow, meaning you are not paid much to take risk. PFF is a preferred stock and baby bond ETF that operates in a terrible manner and should greatly underperform a logical fixed-income investor. Thus, your risk can be mitigated by shorting PFF to hedge some of your portfolio, and at Interactive Brokers you can even get paid for shorting PFF. Shorting some PFF shares is a great way to feel more comfortable holding your undervalued securities in a dangerous market, and if you are a good fixed-income investor/trader you can handily beat PFF. Shorting PFF can be used to allow you to increase your long positions without increasing your market risk. And one of the reasons that you can outperform PFF on the long side is that this market has many mispricings. While PFF can't take advantage of that and often owns many overvalued securities, an individual investor can focus on the undervalued securities available to him/her.  Lastly, I mentioned some very overpriced securities that readers should sell or avoid, some which are held by PFF. These are FTAIO, PRIF-K, MAA-I, OCCIO, PEB-F, HTFB, and OXLCL.","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.3","shortVersion":"4.29.3","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2479324427"}