Market Commentary | April 17, 2023

Purgatory at the Point of Inflection

About a year ago, in our search for yield that was safe in a rising rate, inflationary environment, we identified a multi-billion-dollar pool of fixed-to-floating rate preferreds we could buy at meaningful discounts to par that would provide high initial yields that would rise with interest rates. The issues’ floating rate coupons are typically tied to 3 Month USD LIBOR + a few hundred basis points (at the time 3M LIBOR hovered at just over 1%). We bought a full spectrum of issues and three of them have now converted to floating rate issues that pay dividends above their at-issue face coupon.

In the interim, 3 Month USD LIBOR has soared to 5.26%. At that elevated rate, these preferreds now offer yields at conversion that range from 10-14%. Amazingly, most days shares still trade at the 10-20% discounts to par that was available last year.  Even more amazing (and opportunistic) is that the market malaise has spread to a broad spectrum of equity REIT preferreds. We are intrigued and participating.

Last fall we saw that during periods when broader stock investors headed for the exits, REIT preferred shares declined despite what might be going on with interest rates. When investors waded back into the blue chip and tech issues, the preferred shares stayed down and, in some cases, continued to decline.  The desire to be away from risk/out of these REITs persisted and shares have sold down in the absence of emerging buyers. We know these companies intimately and the market has provided the opportunity to capture 8-10% dividend yields at unjustifiably discounted prices of shares from the residential, healthcare, retail, industrial, and hospitality sectors.

Because markets eventually normalize, we have been able to sell the shares for small capital gains and move on to new opportunities. Because economic unease and anxiety persist, we’ve seen this price dislocation repeat and we have been in and out of some of these issues three times over the last three quarters.

With the release of each economic data point, the debate begins anew about whether the Fed will continue its inflation-fighting hikes or pause.  It’s a state of investor purgatory around the inflection point for interest rate trends.  We are admittedly in limbo too, but knowledgable and ready to seize profit as it presents itself.

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