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CEF INSIGHTS PODCAST: NUVEEN'S PREFERRED SECURITIES STRATEGY FOR NAVIGATING MARKET CHALLENGES


Exposure to the preferred securities sector provides a degree of portfolio diversification investors may not get from traditional fixed income. In this CEF Insights Podcast episode, Nuveen portfolio managers discuss how preferred securities strategies can help investors navigate current market challenges, and the outlook for the preferred sector and broader market.


Nuveen, the investment manager of TIAA, offers a comprehensive range of outcome-focused investment solutions including preferred securities. Its Nuveen Preferred and Income Fund, ticker JPT, Nuveen Preferred and Income Opportunities Fund, ticker JPC, Nuveen Variable Rate Preferred and Income Fund, ticker NPFD, and Nuveen Preferred and Income Term Fund, ticker JPI, aim to generate current income and total return.

 
Featuring:

Paul BlomgrenPaul Blomgren, CFA
Client Portfolio Manager, Global Fixed Income, Nuveen

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Douglas Baker, CFA Nuveen First TrustDouglas Baker, CFA
Portfolio Manager & Head of Preferred Securities Sector Team, Nuveen

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Brenda Langenfeld, CFA, NuveenBrenda Langenfeld, CFA
Portfolio Manager, Global Fixed Income, Nuveen

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Listen here:

Podcast Transcript:

CEFA:

Welcome to CEF insights, your source for closed-end fund information and education brought to you by the Closed-End Fund Association. Today, Paul Blomgren, Client Portfolio Manager, Doug Baker, Portfolio Manager and Head of the Preferred Security Sector Team, and Brenda Langenfeld, Portfolio Manager, each with Nuveen, will discuss the challenges the current market environment presents to income-oriented investors and the potential for strategies featuring preferred securities to address these challenges. Doug and Brenda manage four closed-end funds, Nuveen Preferred and Income Fund, ticker JPT, Nuveen Preferred and Income Opportunities Fund, ticker JPC, Nuveen Variable Rate Preferred and Income Fund, ticker NPFD, and Nuveen Preferred and Income Term Fund, ticker JPI.

Paul, Doug, and Brenda, we look forward to your discussion.

Paul Blomgren:

Great. Thank you. We appreciate you having us today.

Doug, why don't we start with you? We'll start looking generally at the fixed income markets. Obviously the Federal Reserve is raising interest rates, but inflation's still been running high. And if that continues, it could force the Fed to even be more aggressive. And we also have significant geopolitical tensions that add to the volatility, given that, where do you see the fixed income markets currently? And what's your outlook for the rest of the year 2022 and into 2023?

Doug Baker:

Yeah. Thanks Paul. So your observations are absolutely correct. Interest rates have moved higher this year, reflecting the jump in inflation and the expected Fed's response, which we've seen. And some of this is still to be determined. We've also seen spreads move wider as well reflecting what has perceived increased risks in the marketplace. Geopolitical, some reflecting increased likelihood of a recession and the Fed itself unknown really how the Fed is going to react with the changing inflation backdrop also adds some risks to the marketplace. But where we stand today, we're off the highs in rates and we're off the wides in spreads, but we do feel that both higher rates and wider spreads have priced in Fed and inflation expectations as well as credit related risks. So it's not so much that we necessarily need to move meaningfully from where we are today. There's a lot that's already priced into the market.

And I think that's important for investors to understand. Now, today it happens that we had our CPI print and it makes me, looking at the data, both headline and core came in lower than expected. And it makes me a little more optimistic that the Fed is making progress and that the supply chain issues are starting to abate. Things like substitution effects and changing logistics that just takes time. There's not much the Fed can do to control that. So I think what gives us a little bit more of an optimistic view is that, not only do we see Fed actions having the desired impact or starting to have the desired impact on the factors that they can control, but also some of these other issues that are outside of their grasp that are more supply chain related seem to be coming down in the right direction as well.

Now I will say that today's data was not enough really for the Fed to fully relax, but it does take the pressure off, I think, the Fed to be super aggressive going forward. Which also at the same time lowers the likelihood of the Fed overshooting too badly. Now today, as I speak, the 10 year rate is around two and three quarters percent. And here at Nuveen, we do expect that the 10 year is probably going to end up somewhere between three and three and a quarter percent by year end. So we're still in the camp that it pays to be slightly defensive when it comes to interest rate risk. And for 2022 more broadly speaking and barring any unforeseen developments. I think that gives us an idea of where we're going to end up on rates, but I think we also have an opportunity for credit spreads to continue their trend lower.

Now it may be a little bit of a bumpy ride, but we think the longer term trend into year-end is for credit spreads to continue to grind lower. And I think that we also might have some technicals in place that can help with that. We've had a tremendous amount of new issue supply, not just in our market, in the preferred market. It's been a little lighter there, but more broadly speaking in the investment grade bond market. And that's just put pressure on spreads to remain elevated across all of fixed income and our outlook and the streets outlook is that new issue is likely to slow down going into the end of the year. So we do feel that technicals will also add to what seems to be a little bit more of a constructive backdrop to bring these credit spreads lower.

Now, for those that are concerned about a recession, either towards the end of this year or in the next year I think one thing to keep in mind is that the starting point is very stable, in our opinion. The consumer and consumption again, accounts for about 70% of domestic economic activity, the consumer is in great shape. They're still sitting on elevated savings that they built up during COVID. Those that want a job seem to have a job. And many people have improved on their jobs. The unemployment rate has dropped dramatically. So we do feel that our starting point, and that's really keep our recession on how severe it's going to be is pretty stable.

Now that being said, obviously, recessions, aren't great, but we do feel that it's likely to be less severe than maybe some are concerned about. Now for 2023, that's a tougher question. That's a bit further out and it gets a bit difficult to really have conviction in calls, but that being said, and assuming that credit hasn't really retraced its full spread widening that we've seen year to date by year end. I expect there will still be opportunities in credit in the preferred space in particular, and that towards year end, hopefully we have a better view on inflation and it's better contained. So the interest rate risk is more of a measurable known. And so I really think when it comes to 2023, again, it's hard to have conviction, but maybe we have a discussion at year end 2022 and reassess really where the opportunities and the risk fly then.

Paul Blomgren:

Great, Doug, it sounds like obviously there's some good opportunities, but despite that progress, what kind of challenges do you think this environment presents to income oriented investors or investors seeking diversification through the traditional fixed income investments?

Doug Baker:

You know, in my opinion, challenges for income investors is really knowing your risks, knowing your risks in your income portfolios and not overexposing to any one particular risk bucket, and diversifying your pools of risk within the portfolio that yet you're using to drive your income. So we want to make sure that investors aren't fully relying on significant credit risk to drive their yield or their income, or a significant duration bet, or using significant amounts of leverage. Now we do think that using bits and pieces of that altogether can help diversify the risk and put together really a healthy income oriented portfolio.

So maybe a little high yield risk with a little higher quality risk to diversify your credit bucket. Maybe some diversifying along the yield curve, as far as your duration exposure is concerned, and then incorporating modest amounts of leverage as well. I think that when you put together a portfolio that has really exposure to those different risk buckets and not taking a focused, concentrated bet on one of those individual areas is probably in my opinion, the safest way to go. And then as one of those buckets, underperforms or outperforms over time, you can reallocate within those first buckets. So really long story short, it's really understanding what risks you're taking in your income portfolio to generate that income. And just making sure that if you are taking a "bet" within that allocation, that you understand it, and more importantly, that you don't accidentally have exposure to a particular risk bucket unintentionally.

Paul Blomgren:

Great. That makes a lot of sense. And Doug given the unique insight and understanding you and the team have of preferred securities, can you talk a little bit specifically about how an exposure to the preferred sector provides a degree of diversification of portfolios that investors might not get from traditional fixed income?

Doug Baker:

Yeah, I think preferreds for sure offer diversification to an overall portfolio, especially for a portfolio that otherwise doesn't have an allocation to preferreds. We have a lot of unique characteristics in our space you don't necessarily find elsewhere. We have high concentration to financial services, in particular banks. Which is a risk, but also we feel in this environment is also quite a compelling attribute. Given that banks are really the primary sector or is the primary sector that's going to benefit from a rising rate environment. And given that most of our issuers are banks and insurance companies, those two sectors are about 75% of our issuer base in the preferred market. Those are typically highly rated issuers and kind of the on average in the mid-single “A” area at the senior level. So preferreds do offer kind of that solution that's high quality. Now we also have a unique risk exposure as well in that most of our securities are subordinate.

So that provides typically a risk profile for a lot of investors that they may not have in their portfolio. And then there's this dynamic where we do tow the line between debt and equity. Some of the securities in our asset class technically are on the equity side of the balance sheet for the issuer and other structures are on the liability side. And then finally we have this really interesting dynamic where we have significant direct retail investor exposure or participation, and that can add its own dynamic as far as price and valuations are concerned and how they move in response to the broader markets.

But at the end of the day, while the preferred category does bring a unique, I think, set of risks and opportunities that helps a broader portfolio become more diversified, at the end of the day, it still is an area of credit within fixed income. And especially during times of distress, it will tend to have a higher correlation to other risk assets in the marketplace. And during those flights to quality tend to have a lower correlation to things like treasuries. But that being said over the long run, we do feel that an allocation to preferreds does help diversify a portfolio, and move an investor a little bit further out on the efficient frontier.

Paul Blomgren:

Doug let's stay with the nuances of the preferred sector in general. Can you talk a little bit about what advantages you have as an active manager in that specific space?

Doug Baker:

Yeah, Paul, so really the key one that we tend to focus on a lot is really the retail investor versus the institutional investor in the preferred market. And we actually have the market that kind of separates itself naturally between those two investor bases. Roughly today, half of the US preferred market is a $25 par exchange traded structure. And because of the smaller size, because it's exchange traded very popular with retail investors, we often refer to that as the retail side of the market. The other half of the market is a thousand dollars par denominated security that trades over the counter, like a corporate bond. And because of the larger size, because of trades over the counter, that tends to be more traffic by our institutional investors. Now those two investor bases will look at risk and price it quite differently at times. And today the credit spreads between the two sides of the market are very wide from one another.

So we do have an opportunity, as an active manager, to toggle between these two sides of the market when we see inefficiencies. Now there's other things that we highlight too, that active management can bring to the table. And in particular, it's managing interest rate risk. For those that aren't familiar with the preferred category, a lot of our securities are perpetual, and if they're not perpetual, if they have a maturity date, oftentimes at new issue, the maturity dates are 40, 60, 80 years out. Now, that doesn't necessarily mean that you have to take a lot of duration risk if you invest in preferreds, because first, most preferreds are callable. And that call feature also will affect the interest rate risk or the duration profile of these securities. But there's also a large population of securities that have what we call fixed to variable rate or variable rate coupon structures.

And these coupons that have the potential to adjust in the future greatly bring down the duration profile and duration extension risk that you would find to a comparable preferred that pays the same fixed rate coupon over its entire life, all else equal. So we here at Nuveen, as active managers, one of the things that we do focus on is taking conservative positioning when it comes to interest rate risk. And we accomplish that primarily through the structures that we own. And we focus primarily on those adjustable rate coupon structures across our strategies. So I would say there's a lot of opportunity, not only for an active manager to capitalize on relative value opportunities and mispricing between different segments of our market, but also to help manage risk actively and, in particular, interest rate risk for investors in the preferred category.

Paul Blomgren:

Great. Thank you, Doug. We'll come back to you in a second. Let's turn to Brenda here. Brenda, we mentioned the four closed-end funds you manage JPI, JPC, JPT, and NPFD that all focus on preferred securities. Obviously from a broader perspective, all of these and our preferred exposure in general, give us exposure across the globe, but more specifically, how would you expect preferreds to perform going forward? Given that outlook that Doug just talked about?

Brenda Langenfeld:

Thanks, Paul. Yeah, fundamentally speaking banks are very well positioned. They had a very strong 2021. And like you said, this is globally. So we are not expecting if we're looking for recession in 2023, this will not be a repeat of the financial crisis. And as Doug laid out, there's this appetite for higher quality. So you get that through the asset class, via the sector being banks, the largest exposure there. So high quality issuers, but also within structures. So higher quality structures, what we deem to be higher quality structures, whether it be a higher upfront coupon, a more generous reset spread for those fixed to variable structures, with the backdrop that the banks are very well positioned from a capital standpoint, we would expect those securities to perform well in a shallow recession type scenario. If rates continue to rise. And even if we stabilize where we are currently compared to where we started the year.

So we expect to see continued outperformance of those fixed to variable rate securities. So that is fixed to fixed rate, fixed to floating rate and even securities that have now moved into a floating rate period of their life. Also, as more clarity and stability arises, we have that potential for spread compression that Doug laid out earlier. So we are in a very attractive position for some spread compression.

Flipping to technicals, supply has been very limited so far this year, specifically in preferred, and we expect that to continue. So that is another tailwind for the asset class. We've already mentioned the strong capital levels that you find banks. So there really isn't much capacity or need to outright issue capital securities for the banking sector. The focus will continue to be on refinancing activity, but with the market rates moving higher this year, there aren't as many securities that make sense to revive from the bank's perspective, it's more economic to allow securities to remain outstanding and perhaps move into that floating rate period of their life, if it's fixed to variable rate. Also, factoring in the odds of some rate cuts in 2023, banks may not feel rushed or pressured to refinance something immediately at the first call date in 2023, it may make more sense for those securities to extend. So again, from a supply standpoint, it's also a very positive picture there for the asset class.

Paul Blomgren:

Great. Thank you, Brenda. Given that, I mean such a broad global market, can you talk to us a little bit about the process you use to sort of distill that down into a workable set of potential investments?

Brenda Langenfeld:

Certainly. So we focus on the three major segments of the capital securities universe. That would be that $25 par or the listed securities, the thousand dollars par preferred securities, as well as contingent capital securities. And really our process is agnostic among those three major segments. So first we take a top down focus on highly regulated industries, banks being our largest exposure in our portfolios, but also the largest component of the universe. So we really look at what are capital needs for the banks and that's why they issue preferred securities.

From a bottom up perspective, we utilize the expertise of our credit analysts to really focus on stable or improving issuers. They will take a pure fundamental credit read. Then we'll have the portfolio management team in collaboration with our traders, our trading team we'll make decisions based on various factors of liquidity, coupon structure, fixed rate, fixed variable, any potential supply. As Doug mentioned too, interest rate outlook, option adjusted spread, just to name a few examples, Doug and I will then implement those ideas again, collaborating from credit analyst team, as well as trading to put those ideas in the portfolios.

Paul Blomgren:

Great. Brenda, let's stay with the investment process and just dig a little bit deeper into that portfolio construction. So then take it to the next step. How do you make specific security selections and then make the decision how you allocate those in and across those portfolios?

Brenda Langenfeld:

Yeah, so we use our benchmark really as a guidepost for portfolio construction, but we do have very broad mandates that allow us to express meaningful overweights and underweights. Whether that would be $25 par versus thousand dollars par or our coco or contingent capital allocation, even just non-US exposure overall. So we do have a lot of latitude there, which again comes back to using the benchmark as really a starting point to how we want to express relative weightings.

Again, we collaborate with our credit analysts and our trading teams to source the best ideas and risk adjusted returns. And then also with that input, particularly from trading to ensure that they are actionable trade ideas to establish positions, we really do. It's the PM team and trading teams that apply on that structure and relative value. Whereas I mentioned before, the analyst team is responsible for a pure fundamental credit read. Generally we'll have a pro-rata allocation across the platform, but we are mindful of any portfolio constraints that may require us to deviate from that. Some examples might be if we're in an investor period or differing in leverage targets, or even specifically for NPFD, where there is a 20% max on contingent capital securities, you'll see some deviation from that. But generally speaking, we have very consistent positioning among our variety of products.

Paul Blomgren:

Brenda, what would cause adjustments in positioning? For example, if you know, there was key factors or events, what would those be that might lead you to sell a security or maybe take a major shift in portfolio allocation, maybe across Cocos or any of the major sectors?

Brenda Langenfeld:

Relative value, again collaboration with trading to be very up to speed and relative value dynamics, even just within the same ticker of an issuer. So relative value is an example of where we might exit a security, perhaps it's screening too rich compared to the rest of the investment universe. Liquidity has been a reason or perhaps lack thereof. If we felt like we wanted to not be invested in a security that is less liquid. And we felt like it was an opportune time to exit that security specific to a credit. If we have a deterioration of credit. So a credit analyst gives us a refreshed read that something has changed meaningfully for a specific issuer.

Other examples of where we've sold securities is geopolitical events. So, that could be within a country due to elections. That could be within a region. Those are some other examples of where we've exited some positions. And finally, from a technical standpoint. And this is where the highly regulated bank sector and coming out of the financial crisis where transparency is better than ever for not only preferred investors, but in credit investors overall. We have a much more transparency in terms of what expected supply would be from issuers. So it might be that we would sell a position ahead of anticipated issuance from the same issuer.

 Paul Blomgren:

Great. Obviously all the funds you run, Brenda are managed somewhat differently and have nuances, but can you talk to us sort of maybe give us some general themes around current positioning and where you guys are finding the trend of opportunities today?

Brenda Langenfeld:

Certainly. To start out, JPC, JPI and JPT all have the same blended benchmark and generally the same portfolio parameters, especially high level. The inception dates of course do differ. So they were each invested up in different time periods. JPC has the longest track record, and it is the largest of the three. JPC and JPT are both perpetual funds. Whereas JPI has a 2024 term date. So that may lead to JPI price converging to NAV at near as its sunset in 2024. So that's a distinction there compared to JPC and JPT.

Turning to NPFD, that is our most recent offering. So we've launched that in December 2021. It has a target term of 2034, and it is named Variable Rate Preferred and Income Fund. So currently 100% of the invested securities have that fixed to variable rate coupon structure. So you'll find an overweight to those coupon structures in our other closed-end funds, but NPFD is the only one with an explicit constraint. So we don't have as much latitude. If we wanted to deviate from that positioning in the other portfolios, we don't have that as much latitude in NPFD as the others.
There's also that I mentioned the 20% max on contingent capital securities. So, as I said, as you'll see very similar tickers among the portfolios, but generally you'll see a lower absolute allocation to almost all of them compared to those other more seasoned closed-end funds.

Finally, moving to the valuations and opportunities. We continue to favor a thousand dollars par securities over $25 par securities. As Doug laid out, not only based on relative value. So $25 par securities are richer comparatively to a thousand dollars par segment on an OAS basis, but also because of the coupon structure differences. So, thousand dollars par is where you'll find the bulk of the fixed variable rate structure. That coupon structure is largely absent in the $25 par space. And another opportunity, while new issue supply has been sporadic in 2022, we have noticed a reemergence in recent months of a new issue concession. Particularly compared to 2021. That's given this heightened uncertainty during this year. So we're finding some good opportunities in the albeit limited, because there isn't much but finding good opportunities in the primary markets, which is welcome compared to how 2021 priced securities.

Paul Blomgren:

Great. Brenda, that sounds like some good developments this year, at least optimistically, right?

Brenda Langenfeld:

Yes.

Paul Blomgren:

Let's turn back to Doug here. One last question for you, Doug. How do you see investors using preferred strategies effectively in income-oriented portfolios overall?

Doug Baker:

Yeah, absolutely. So believe it or not, this is probably one of the most common questions that Brenda and I get from investors. Where do I put preferred? What are preferreds? Are they fixed income? Are they equity? Are they something else? And typically we have to respond with kind of a mealy-mouthed type of answer. So first if you ask us here at Nuveen, if you ask other firms on the street, they're generally going to consider preferred securities as a segment within the fixed income market. And when you look at families of fixed income indices, that's where you find preferred indices. However, what we have found is that oftentimes it depends on how an advisor or an investor views their allocation to fixed income. So for example, if a financial advisor or an investor has really positioned the fixed income allocation to be super conservative, lower duration, super high quality, say municipal securities, then preferreds may not be a fit within that allocation.

What we tend to tell people to guide expectations is that price and spread volatility within the preferred market is somewhat similar to what you would experience in high yield. Now the risks are very different. The underlying issuers between preferred and high yield are very different. And one side of that market, the high yield market, you have a higher likelihood of some incidents of default or impairment. Where in the preferred market, it's typically a lower likelihood of default, but your recovery rate is a lot lower than what you would find in high yield. So, those risks are very different, but the volatility of the prices of the securities over time, it tends to be pretty close to one another. So what we tell people is, if you're comfortable with allocating high yield to your fixed income bucket, then we think you should be okay allocating preferreds to your fixed income bucket as well.

Now, if somebody says, ah, high yield's a bit risky, we really don't allocate to that, especially not in our fixed income bucket. Then preferreds might find a better home in the equity allocation for that investor, or for that advisor. And if that doesn't work, if people just say, Hey, preferred, it's kind of this asset class that, as I mentioned earlier, tows the line between debt and equity, I'm actually not going to try and put this square peg in around hole. I'm going to put it in a completely different bucket. It's not fixed income, it's not equities, it's something else. It might be an "other bucket” or an alternatives bucket.

If we had to put an estimate around the allocation that we see from our end, I would say roughly 75% to 80% of the time we see preferreds allocated to a fixed income segment of an overall portfolio. And then I'd say roughly 5% of the time it's to that other kind of alternatives bucket. And the rest of the folks tend to allocate it to equity. So there is some flexibility there, and to where people can allocate preferreds within a broader portfolio. And I think really, at any given time, it's because of the hybrid nature of the asset class there's very good reasons or rationale to allocate your preferred exposure to one segment of the market versus the other.

Paul Blomgren: 

Thank you, Doug. And as always, it's a pleasure talking to both you Doug and Brenda, thank you guys for your time today.

Brenda Langenfeld:

Thanks Paul.

 Doug Baker: 

 Thanks Paul.

CEFA: 

And we want to thank you for tuning into another CEF Insights Podcast. For more educational content, please visit our website at www.cefa.com.

This material is not, and is not intended as investment advice, an indication of trading intent or holdings or the prediction of investment performance. All fund-specific information is the latest publicly available information. All other information is current as of the date of this presentation. All opinions and forward-looking statements are subject to change at any time.

Nuveen disclaims any responsibility to update such views and/or information. This information is deemed to be from reliable sources however, Nuveen does not warrant its completeness or accuracy. This presentation is not intended to and does not constitute an offer or solicitation to sell or a solicitation of an offer to buy any security, product, investment advice or service (nor shall any security, product, investment advice or service be offered or sold) in any jurisdiction in which Nuveen is not licensed to conduct business, and/or an offer, solicitation, purchase or sale would be unavailable or unlawful.


Audio recorded on August 10, 2022.

About the CEF Insights Podcast

Presented by the Closed-End Fund Association (CEFA), the CEF Insights Podcast provides investors with closed-end fund education, insights, and perspectives. The CEF Insights Podcast is available on CEFA.com, Apple Podcasts, Seeking Alpha, Spotify, and other leading podcast platforms. 

 

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