PSF: Continues To Underperform Peers And Another Failure To Cover The Distribution

The Cohen & Steers Select Preferred and Income Fund (NYSE:PSF) is a closed-end fund, or CEF, that income-focused investors can purchase as a method of achieving their income goals. The fund does fairly well at this task, as it currently boasts a 7.82% yield. This is in line with many of the fund’s peers, but this one is far from the highest-yielding option that is available to investors in preferred stock funds:

Fund Name	Morningstar Classification	Current Yield
Cohen & Steers Select Preferred and Income Fund	Fixed Income-Taxable-Preferreds	7.82%
First Trust Intermediate Duration Preferred and Income Fund (FPF)	Fixed Income-Taxable-Preferreds	9.23%
Flaherty & Crumrine Preferred Securities Fund (FFC)	Fixed Income-Taxable-Preferreds	6.87%
John Hancock Preferred Income Fund (HPI)	Fixed Income-Taxable-Preferreds	8.94%
Nuveen Preferred & Income Opportunities Fund (JPC)	Fixed Income-Taxable-Preferreds	7.93%

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As we can see here, the yield of the Cohen & Steers Select Preferred and Income Fund is reasonably in line with the preferred stock closed-end funds that are available from Flaherty & Crumrine and Nuveen. However, it falls short of all of John Hancock’s offerings, as well as the First Trust Intermediate Duration Preferred and Income Fund. Investors in preferred stock funds typically like to maximize their incomes, so the tendency would be to put their money into a fund with a higher yield. The fact that this one is lower than a few of its major peers is therefore a strike against it.

Another potential issue for investors in this fund is inflation. In a previous article, I pointed out that the headline consumer price index understates inflation. GIS Reports made the same observation back in March. As the international consulting firm states:

In recent decades, many have criticized the way CPI figures are calculated, highlighting their limitations in accurately capturing real inflation, or even pointing to bias on the part of their publishers. Chief among these problems is the very basis of the calculation: the concept of a “fixed basket” representing a predetermined set of goods and services that reflects the average consumption pattern in a specific base year. This includes basic food and beverages, housing rental, clothing, transportation and medical care costs, as well as education, communication and recreational expenses.

The GIS Reports article goes on to devote multiple paragraphs (the article itself is a roughly ten-minute read) explaining problems with the methodology used to calculate inflation. The big ones are that it excludes asset inflation and that it is subject to adjustments that impart selective bias to the figures (possibly allowing politicians to make inflation claims that are contrary to reality). This should not really be debatable, since if inflation was genuinely at under 2% throughout the 2010s then median house prices in the United States would not be at $420,800 right now. They would be considerably lower.

Economist John Williams at Shadow Stats has regularly published alternative measures for the inflation rate based on the methodology used to calculate inflation before the changes that were implemented in the 1980s and 1990s:

As is the case with Larry Summer’s figures that I showed in my previous article, the above charts show an inflation rate that is at least double what the official headline numbers suggest. This is important for our purposes today because it would mean that the yield of the Cohen & Steers Select Preferred and Income Fund is less than inflation. Recently, there has been a growing crowd of economists suggesting that high inflation may become a permanent fixture of the economy, so this could be something that we need to keep in mind when evaluating any fund. Admittedly, though, any closed-end fund that invests in fixed-income securities is going to have this problem.

As regular readers can likely remember, we previously discussed the Cohen & Steers Select Preferred and Income Fund in mid-January 2024. At the time, I stated that the Federal Reserve would be unlikely to cut interest rates to the degree that the market was expecting. This prediction has since proven to be correct, and bonds have generally sold off over the past four months. The Bloomberg U.S. Aggregate Bond Index (AGG) is down 1.71% since the date that the previous article was published. Preferred stocks have generally held up better, but shares of the fund are still down as predicted:

As shown here, shares of the Cohen & Steers Select Preferred and Income Fund are down 0.46% since the date that the previous article on it was published. This is better than the performance delivered by bonds over the period, but it is worse than the 0.70% gain that the ICE Exchange-Listed Preferred & Hybrid Securities Index (PFF) managed to deliver over the period.

However, as I pointed out in my last article:

The fund’s investors have received far more gains than are visible simply by looking at the fund’s share price. This is because closed-end funds such as the Cohen & Steers Select Preferred and Income Fund typically pay out all of their investment profits to their owners, which results in their realized returns being much higher than the share price performance would imply.

When we include the distributions paid by the fund in the performance chart shown above, we get this:

The distributions paid by the Cohen & Steers Select Preferred and Income Fund were sufficient to offset the share price decline and give the fund’s shareholders a 2.80% total return since mid-January. This is certainly much better than the loss implied by the previous chart, but it is still not sufficient to allow this fund to beat the preferred stock index. As expected, it does still manage to outperform investment-grade bonds, which is at least partly because the yield of investment-grade securities is still remarkably low. Overall, though, we can still see the scenario that I outlined previously playing out as the fund not only underperformed the index but also underperformed all of its peers:

It is not a coincidence that the two highest-yielding funds were also the top two performers, as the yield of a fund plays a huge role in determining its performance when dealing with fixed-income securities.

About The Fund

According to the fund’s website, the Cohen & Steers Select Preferred and Income Fund has the primary objective of providing its investors with a very high level of current income. Specifically, the website states:

The primary investment objective of the Fund is high current income through investment in preferred and other income securities. The secondary investment objective is capital appreciation.

As regular readers will certainly notice, this description does not provide any conclusive statement about the percentage of the fund’s assets that will be invested in preferred securities or other income-producing securities. It can be presumed that the fund will maintain an 80% or higher weighting to preferred instruments based on this statement, but it does not directly state that. In fact, the statement mostly suggests that the majority of the fund’s assets will be invested in anything that has a yield higher than zero. However, the fact sheet provides the following asset allocation:

That implies that the fund’s allocation is 100% preferred securities. This is mostly accurate, but not completely. The fund’s annual report provides the following asset allocation as of December 31, 2023:

Security Type	% of Net Assets
Preferred Securities – Exchange-Traded	27.4%
Preferred Securities – Over-The-Counter	122.2%
Money Market Fund	0.7%

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As we can see, the fund’s assets consist solely of preferred stock along with a small amount of cash. We would normally expect that the fund would have a small amount of cash stored in a money market fund that it can use to pay the distribution or make investments. It is rather curious, though, that the fund has no money allocated to any other income-producing assets, such as bonds.

As we have seen in various other articles, many peer funds do include small investments in bonds or dividend-paying common stock alongside their majority preferred stock allocations. For example, the Q1 2024 Holdings Report for the First Trust Intermediate Duration Preferred & Income Fund shows a 2.6% weighting to foreign bonds, with the remainder of the fund invested in preferred stock. It is a small weighting that obviously does not change the overall objectives of the portfolio, but even small allocations can change the fund’s performance slightly. The Cohen & Steers Select Preferred and Income Fund appears to be a pure-play preferred stock fund right now, which could very well be what most individuals who purchase a fund like this would like.

In our previous discussion of the Cohen & Steers Select Preferred and Income Fund, we saw that the fund was heavily exposed to the banking sector. From that article:

The first thing that we notice here is that all of the securities in the fund’s largest positions list are either utilities or banks. This is not uncommon for a preferred stock fund because banks and utilities are the largest issuers of preferred stock in the market. As a result, almost any preferred stock fund will be very heavily weighted towards these two types of companies. With that said though, usually the overwhelming majority of companies in the top ten list are banks. This is due to international banking regulations that require banks to hold a certain percentage of their assets in the form of Tier One capital. Tier One capital refers to that proportion of a bank’s assets that are not simultaneously a liability to somebody else (such as a depositor). When regulators require that a bank increase its Tier One capital, its only options are to issue either common or preferred stock. The bank will often choose to issue the preferred stock in order to avoid diluting the common shareholders.

The fund’s largest positions list still consists largely of banks and utilities, but there is greater variety now than the last time that we discussed this fund. Here is the list as of March 31, 2024:

As we can see, the list now has eight banks, a pipeline company, and an interest rate swap among the fund’s largest positions. The last time that we discussed it, it had two interest-rate swaps, an oil and gas super major, a pipeline company, and two utilities. There were only four banks on the list at the time. The fund has therefore reduced its exposure to the two utility companies in favor of banks. The fund also appears to be increasing its interest-rate exposure slightly due to the absence of one of the two interest-rate swaps that it was using to protect itself from rising interest expenses due to its use of leverage.

Despite what the largest positions list might suggest, though, it does not appear that the fund has actually increased its overall exposure to the banking sector. Here is the sector exposure chart provided on the website:

The last time that we discussed this fund, the banking sector accounted for 55.62% of the total assets in the portfolio. Thus, the banking sector exposure has actually gone down as a percentage of assets. However, the fund remains overweight to banks relative to its benchmark index.

The fund does not use the ICE Exchange-Listed Preferred & Hybrid Securities Index as its benchmark, which is almost certainly going to be everybody’s first thought. Rather, the fund uses a hybrid benchmark of its own design, which is detailed in the annual report:

The Linked Blended Benchmark is represented by the performance of the blended benchmark consisting of 50% ICE BofA U.S. Capital Securities Index and 50% ICE BofA Fixed Rate Preferred Securities Index through December 31, 2016; the blended benchmark consisting of 60% ICE BofA U.S. IG Institutional Capital Securities Index, 30% ICE BofA Core Fixed Rate Preferred Securities Index and 10% Bloomberg Developed Market USD Contingent Capital Index through December 31, 2018; and the blended benchmark consisting of 60% ICE BofA U.S. IG Institutional Capital Securities Index, 20% ICE BofA Core Fixed Rate Preferred Securities Index and 20% Bloomberg Developed Market USD Contingent Capital Index through March 31, 2022; and the blended benchmark consisting of 55% ICE BofA U.S. IG Institutional Capital Securities Index, 20% ICE BofA Core Fixed Rate Preferred Securities Index and 25% Bloomberg Developed Market USD Contingent Capital Index thereafter.

One of the reasons that the fund is using a hybrid benchmark index is probably because of the high proportion of over-the-counter preferred stock present in its portfolio. As a result, the ICE Exchange-Listed Preferred and Hybrid Securities Index would not be appropriate because it specifically excludes over-the-counter securities.

The fund is even more overweight in the banking sector relative to its benchmark than it was the last time that we discussed it. Recall that the previous article showed that the fund’s banking sector weight exceeded that of the index by 0.94%. Today, that figure has increased to 1.31%. Thus, while the portfolio’s overall banking sector allocation may have gone down over the past four months, it appears that the fund is still betting more heavily on that sector’s preferred stock performance going forward than previously.

In various previous articles on preferred stock funds, including the previous one, I mentioned that the banking sector in aggregate is sitting on enormous unrealized losses due to the fall in U.S. Treasury prices since 2021. This was ultimately one of the deciding factors that brought down Silicon Valley Bank last year, which prompted the Federal Reserve to create an emergency lending facility to ensure that there would not be a similar event. That emergency lending facility ended in March, as Reuters reports:

The Federal Reserve on Wednesday said a funding lifeline created for banks last year after the collapse of Silicon Valley Bank threatened to spark a wider financial crisis would close as scheduled in March.

The Fed also raised the interest rate on new loans from the Bank Term Funding Program for the remainder of its life, effectively ending what had become a popular and profitable arbitrage opportunity for U.S. lenders, which analysts said should deter fresh borrowing.

The sun-setting of the program on March 11 had been signaled by Fed officials as fear in the banking system abated.

Thus, the banking system as a whole is perhaps more vulnerable to bank failures than it was the last time that we discussed it. We have already seen this increased risk of failure take its first victim as Philadelphia’s Republic First Bank failed at the end of April. Thus, the risk of loss from the banking preferreds held by the Cohen & Steers Select Preferred and Income Fund is higher than it was back in January. However, we can see that many of the fund’s preferred stock holdings consist of preferred securities issued by some of the largest banks in the world. Most of these banks are in pretty good financial shape, and it is, in fact, these banks that tend to be chosen by regulators to absorb any bank that fails. As such, we probably do not need to worry too much about the specific preferred securities held by this fund, even though the risk of bank failures is higher than it was only a few months ago.

Leverage

The Cohen & Steers Select Preferred and Income Fund employs leverage as a method of boosting the effective yield that it earns from its portfolio. I explained this concept in my previous article on this fund:

In short, the fund is borrowing money and using that money to purchase preferred stock and bonds. As long as the purchased securities have a higher yield than the interest rate that the fund has to pay on the borrowed money, the strategy works pretty well to boost the effective yield of the portfolio. As this fund is capable of borrowing money at institutional rates, which are considerably lower than retail rates, this will usually be the case. It is important to keep in mind though that this strategy is much less effective today with rates at 6% than it was a few years ago when rates were near 0%. This is because the difference between the interest rate paid by the fund and the yield of the assets that it purchases is much less than it once was.

However, the use of debt in this fashion is a double-edged sword because leverage boosts both gains and losses. As such, we want to ensure that the fund is not employing too much leverage because that would expose us to an excessive amount of risk. I generally do not like to see a fund’s leverage exceed a third as a percentage of its assets for this reason.

As of right now, the Cohen & Steers Select Preferred and Income Fund has leveraged assets comprising 33.60% of its assets. This is, unfortunately, a bit higher than the one-third of asset levels that I would ordinarily prefer. It is not that much higher, however, so it is probably okay. The fund’s leverage is surprisingly lower than the 34.52% level that it had at the time of our previous discussion.

The explanation for this can be found in the fact that the fund’s net asset value has increased since the time of our previous discussion. This is shown here:

The fact that the fund’s net asset value has increased over the period runs counter to the fact that the share price has declined. However, as I pointed out in the previous article, the fund’s share price was a bit higher than its historical level relative to net asset value at that time. Thus, what we are seeing here is that the fund’s market price fell back closer to its historical median. We will discuss this later in this article. For now, the important thing is that the fund’s leverage has decreased a bit relative to the value of its assets, and this is quite nice from a risk management perspective.

Here is how the fund’s current leverage ratio compares to its peers:

Fund Name	Leverage Ratio
Cohen & Steers Select Preferred and Income Fund	33.60%
First Trust Intermediate Duration Preferred and Income Fund	33.88%
Flaherty & Crumrine Preferred Securities Fund	38.90%
John Hancock Preferred Income Fund	37.31%
Nuveen Preferred & Income Opportunities Fund	37.72%

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(All figures from CEF Data.)

As we can see, the Cohen & Steers Select Preferred and Income Fund appears to employ a lower level of leverage than most other preferred stock funds. Risk-averse investors should appreciate this because it should mean that any market declines or even defaults will have a lower impact on this fund than it would on a peer that is holding the same security.

Distribution Analysis

The primary objective of the Cohen & Steers Select Preferred and Income Fund is to provide its investors with a high level of current income. The fund does this by paying a monthly distribution of $0.1260 per share ($1.512 per share annually) to its shareholders. The fund has not been especially consistent regarding its distribution over the years, as the payout has steadily declined over time:

As I stated previously:

Prior to the COVID-19 pandemic, this fund was a fairly reliable source of income, but the recent cuts have undoubtedly reduced its appeal in the minds of those investors who are seeking a safe and consistent income from the assets in their portfolios. The generation of income is perhaps more important today than it was in past years due to the negative impact that today’s high levels of inflation have had on our standard of living. It costs much more to maintain a certain lifestyle today than it did a few years ago, so we need our incomes to be climbing with the passage of time. This fund’s distribution cuts have been doing the exact opposite.

Naturally, though, the important thing for us today is to determine how well the fund can maintain its current distribution. For this purpose, we have the fund’s annual report to assist us. This report corresponds to the full-year period that ended on December 31, 2023, so it is much more recent than the financial information that was available to us back in January.

For the full-year period that ended on December 31, 2023, the Cohen & Steers Select Preferred and Income Fund received $18,723,439 in interest and $4,065,787 in net dividends (dividend payments minus foreign withholding taxes) from the assets in its portfolio. This gives the fund a total investment income of $22,789,226 for the period. The fund paid its expenses out of this amount, which left it with $12,010,023 available for shareholders. This was not sufficient to cover the $18,833,905 that the fund actually distributed to its investors.

The fund was unable to make up the difference through capital gains. For the full-year period, it reported net realized losses of $25,492,478 which were offset by $30,711,367 net unrealized gains.

Overall, the fund’s net assets decreased by $1,574,348 after accounting for all inflows and outflows in the period. Thus, the fund failed to cover its distribution. However, the distribution was higher during the first half of the period than the second half, so its distribution this year will cost less money for the fund. It remains to be seen if the fund will be able to sustain the current distribution, but it should be able to get fairly close unless preferred stock prices decline significantly from today’s level. That is a possibility, given that interest rate expectations may still be too optimistic. Overall, though, the worst has probably already been done, since an interest rate hike seems unlikely.

Valuation

Shares of the Cohen & Steers Select Preferred and Income Fund currently trade at a 7.83% discount to net asset value. This is a bit worse than the 8.80% discount that the shares have had on average over the past month.

Conclusion

In conclusion, the Cohen & Steers Select Preferred and Income Fund exhibited signs of weakness since our previous discussion. This might be partly due to the fund’s inability to cover its distribution for the second straight year, but this is hardly a problem that is unique to this fund. The fund also continued to underperform relative to its peers, which is a problem that I highlighted in past articles.

The fund also shares the same problem as most fixed-income products right now, in that its yield is arguably not enough to beat inflation if held in a taxable account. After-tax, this fund’s yield is not beating inflation when using certain methodologies, and this is something that retirees may not appreciate.