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The Cohen & Steers Tax-Advantaged Preferred Securities & Income Fund (NYSE:PTA) ends up hitting a lot of good sectoral notes. Financial exposures dominate the portfolio of preferred stocks thanks to the fact that these often offer qualified dividends. Financials are a decent place to be in the current environment. While the fund has some leverage, it is quite limited, and since this is an income play directed for the purpose of being an income fund first and foremost, it seems to be capable of doing what it was designed for. While duration risk is a factor, the preferred shares do dominate that because they have pro-rata ownership of assets in a theoretical liquidation. Since bank assets are becoming more valuable, that mitigates duration risk to a meaningful extent.

Brief PTA Breakdown

According to the data provided by Cohen & Steers, we see what kinds of allocations this fund has prioritised as of now. Almost all the securities are preferred shares, and in pursuit of ‘tax advantage’, these securities are primarily from qualified institutions in the financial space. There are some exceptions, with a couple of the allocations being in utilities such as power companies but also pipelines. The vast majority are in pretty traditional looking banks, brokerages and some insurance. Obviously, the full-service banks feature highly on the list.

PTA top holdings

Top Holdings (Cohen & Steers)

In addition to that, we point out some other key facts. The leverage ratio is 37%, the ratio being debt on total assets of this closed fund. 37% is not excessive but we do expect some erosion to the funds available for disbursal on account of the rising debt costs. Thankfully, only 15% of the debt is variable rate financing, and the duration on the fixed component is 4 years. In the best case scenario, this is long enough to outlast the current rate hike, and eventual rate decline cycle. But in general, investors need to be aware that persistent inflation could also mean persistently high rates.

Is PTA A Buy?

Firstly, we should comment on the nature of income instruments, especially preferred shares. In practice, preferred shares are valued according to their dividends, not to their ownership of companies, because their pro-rata ownership only begins to matter when recovery scenarios are being considered. Therefore, they are in effect subject to duration risks, and rather severe ones because they are supposed to go on forever and have no maturity. Therefore, their duration is just the effective timing of their cash flows, where later cash flows vanish out in the weighted average in a converging fashion due to mounting discount effects. As rates rise, the fixed dividend on preferred shares are not great.

However, the reality is that preferred shares have ownership over equity, they are just engineered to have less direct influence on how the company is managed and benefit from some of the mitigants that debt has, except being a very junior tranche. This is where the attractiveness of the sector exposures comes in.

PTA sectors

Sectors (Cohen & Steers)

75% of the preferred shares are issued by companies that either benefit directly from the higher rates like banking and insurance, which get better net interest margins and higher investment yields respectively, or benefit from the volatility that higher rates cause, like trading divisions in full service banks or brokerage firms. The only weaker element within financials and banks are investment banking divisions and capital markets advisory businesses. But they usually don’t dominate the income of these companies. On balance, financial equities are going to be some of the few that have the chance at earnings growth in this coming rate induced recession and to hold their value. Therefore, the preferred claim on the equity value of the business should be appreciated. The problem is that for now equity values decline, so this component of the preferred share isn’t really doing great either, and therefore both the fixed income and equity component are suffering justifiably at the moment.

We would consider the duration issue quite seriously, but we do like the exposures and the yield is very sustainable. Moreover, the shares in the fund trade at a discount of about 15% to NAV. If income is what you’re after, this fund should provide reliably. Moreover, the shares have already declined 25% YTD, which reflects at least the current rate hikes, although rate hikes are likely to continue onward. Duration is likely to be the reason for this fund to fall further, but we do like what we see already. We personally pass, but would understand why someone would consider it for their income needs.

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Image and article originally from seekingalpha.com. Read the original article here.

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