Global X Variable Rate Preferred ETF (PFFV): Buy Recommendation

(This article was co-produced with Hoya Capital Real Estate)

Wooden blocks with percentage sign and arrow up, financial growth, interest rate and mortgage rate increase, inflation concept

Introduction

The next chart shows why fixed income investors fear the end of the current interest rate climb has a long way to go.

With the Federal Reserve Board planning increases that could push the Fed Funds rate over 2% by the end of 2023, such fears are justifiable. The Global X Variable Rate Preferred ETF (NYSEARCA:PFFV) is one of the few Exchange-Traded-Funds playing in this space. The concept is as bonds/loans make interest payments or mature, those cash flows will allow the ETF to buy higher coupon assets. Also, unlike fixed-rate funds, every asset will reset to higher coupons on their reset schedule, which will help protect the asset’s price, which moves in the opposite direction to rates.

I found only two ETFs that focus on floating-rate Preferred stocks; the Invesco Variable Rate Preferred ETF (VRP). As assets that will adjust their coupon up as rates increase, preferences should be with type of ETF. While the PFFV ETF is down YTD, and could go lower, I would allocate some of one’s fixed-income allocation to an ETF like this one, thus my Buy recommendation.

Understanding the Floating-Rate Market

Each quarter, Eaton Vance posts a Floating-Rate Loan Market Monitor report. The following information and charts come from that document, starting with defining the floating-rate asset class:

• Corporate debt issued by below-investment-grade borrowers
• Most issuers are significant in size and scale – and many are familiar household names
• Companies undertake loans for recapitalizations, acquisitions and refinancings
• Coupon income from floating-rate loans resets regularly to maintain a fixed spread over a variable base rate, usually LIBOR (and in the future likely to be SOFR)
• Loans are often referred to as “senior and secured”: They typically have the highest priority of claims in an issuer’s capital structure and are secured by specific collateral
• Other common monikers: bank loans, leveraged loans, senior loans (all are synonymous)

The next chart show where floating-rate loans sit in the capital structure; they are the first in line.

Diving into the Global X Variable Rate Preferred ETF

Seeking Alpha describes this ETF as:

Global X Variable Rate Preferred ETF is an exchange traded fund launched and managed by Global X Management Company LLC. The fund invests in the fixed income markets of the United States. It invests in variable rate preferred securities that are denominated in U.S. dollars and have floating or variable dividends or coupons. The fund seeks to track the performance of the ICE U.S. Variable Rate Preferred Securities Index. PFFV was formed on June 22, 2020 and is domiciled in the United States.

Source: seekingalpha.com PFFV

PFFV has just $75m in assets and provides a TTM yield of 5.7%. The mangers charge 25bps in fees. Global X list three reasons to own this ETF:

• PFFV invests in a broad basket of variable rate preferred stock in the U.S., an asset class that has historically offered high yield potential.
• PFFV’s expense ratio is half the competitor average.
• Variable rate preferreds may offer lower duration profiles than fixed rate preferred issuances.

This is the description I found for the ICE U.S. Variable Rate Preferred Securities Index.

The Index is designed to track the broad-based performance of the U.S.-listed variable rate preferred securities market. Qualifying preferred securities must be listed on a U.S. exchange, denominated in U.S. dollars, have floating or variable dividends or coupons, and have a minimum amount outstanding of $50 million. Qualifying preferred securities may, however, be issued by non-U.S. companies. Qualifying securities must be issued in $25, $50, $100, or $1000 par/liquidation preference increments, must have a traded market value of greater than $6 million in each of the previous three calendar months, and must have at least one year remaining to maturity. Constituents in the Underlying Index are capitalization-weighted based on their current amount outstanding times the market price plus accrued interest.

Source: stockmarketmba.com PFTF index

The index follows a quarterly reconstitution and rebalance schedule. Adjustments are made on the last business day in March, June, September, and December.

PFFV Holdings review

I was surprised at the percent of holdings that are Fixed-to-Float/Variable. Without researching each asset, one doesn’t know if they are currently fixed or floating. Based on the Sharpe ratio, PFFV is outperforming its Index.

As expected, Financials dominate the ETF as they do in almost all Preferred Stock funds. They are big issuers as these assets can be counted as part of their regulatory capital. The downside is I believe these issues cannot of the type where making up missed payment is required before common dividends are paid. On the positive side, just over 50% of the portfolio is held in Investment-grade assets, though most is near the bottom of that classification.

Top 14 holdings

Overall PFFV holds only 69 assets. These 14 equate to almost 40% of the portfolio and are the only ones with a 2+% weighting. Notice that all but one assets is listed as “PERP”, which means they have no maturity date. I was unable to find a Call schedule.

The five Issuers where PFFV has the most exposure are:

PFFV Distribution review

Monthly payouts started at $.1225, dropped to $.1205, and in 2022, were raised to $.1250. Hopefully, the recent increase is a sign that the floating-rate provisions are starting the generate more income.

Price history

I was hoping to find more price performance data via the Index used but was unsuccessful, even after visiting the ICE website. With 19 ETFs traded on the U.S. markets, Floating Rate ETFs have a total AUM of $26.84b. That includes asset types beyond Preferreds, like Bank Loans and Treasuries. I reviewed the other ETF focused on Preferred stocks last fall: VRP: Variable Rate Preferred ETF: Nice Choice If Rates Rise (it hasn’t been so far!). Since I just reviewed the PGX ETF, a fixed-rate Preferred ETF, I included it in the next chart to show the relative price movement over the last six months.

Notice, though down in 2022, both Variable-rate ETFs are outperforming the Fixed-rate ETF, as one might expect when rates rise. One reason VRP could be the top performer over this timespan is a higher percent of assets in floating/variable rate assets.

Since PFFV did not exist during the COVID-19 crash, I present the next chart that shows even ETFs can temporarily sell at steep discounts, presenting a “once-in-a-life-time” buying opportunity.

With interest collapsing due to Fed action, here having more floating/variable rate assets caused the larger discount of these two ETFs.

Portfolio Strategy

The $64,000 question is “Why Now?” To help answer that I found a recent document by Charles Schwab that points to the answer being Yes!

While this article is about Variable-rate ETFs, over the last 20 years, the Fixed-rate average price was only much lower during the 2008-09 GFC and then during the COVID-19 crash of 2020. Several of the bottoms were reached at the current pricing point. The current valuations have provided the second best returns.

The next chart shows Variable-rate Preferreds have held up better than their Fixed-rate counterparts since the end of 2020. Only Bank-Loan funds have held up better.

Final Thought

Few of us can call the bottom and neither floating-rate ETF existed during the 2008-09 GFC. PGX did and it had a 55% drawdown with a distinct bottoming when the stock market bottomed. Both VRP and PGX showed the same bottoming pattern during the COVID-19 market correction. Being an ETF, PFFV at least should sell for its NAV, eliminating the risk of selling while it trades at a discount. So I leave readers with this: Considering 1-year CDs are yielding about 1%, PFFV investors could suffer a 4.7% price loss and still be as well off.