First Trust Intermediate Duration Preferred & Income Fund Update

Transcription

1 1st Quarter 2015 Fund Performance Review & Current Positioning The First Trust Intermediate Duration Preferred & Income Fund (FPF) produced a total return for the first quarter of 2015 of 3.84% based on net asset value (NAV) versus a total return of 2.99% for the blended index, a 50/50 blend of the BofA Merrill Lynch Fixed Rate Preferred Securities Index (P0P1) and the BofA Merrill Lynch Capital Securities Index (C0CS). The key drivers of the outperformance relative to the blended index during the first quarter was the use of leverage, which averaged about 31% and added 1.24% of return during the period, and security selection in banks, particularly in securities issued by foreign banks. 1 Detractors from relative performance during the first quarter were an overweighting in institutional securities, fixed-to-floating rate securities and noninvestment grade issues. 2, 3 FPF had close to a 10% overweight in institutional securities, and although the total return of 2.70% on the institutional issues held in FPF was higher than that of the blended index (2.66%), the overweight was a drag on overall relative performance. A good indicator of retail versus institutional performance is the returns of P0P1 and C0CS, which returned 3.38% and 2.59% during the period, respectively. 4 P0P1 is utilized as a proxy for the retail preferred market due to its high weighting in retail securities, whereas C0CS is a better representation of the institutional hybrid securities market. The fund s overweight in variable-rate securities during the quarter was about 19% and the total return for variable-rate securities was 2.86%. 5 Lastly, FPF had a 31% weighting in non-investment grade securities which produced a total return of 2.58% while there are no non-investment grade securities in the blended index. In January 2015, FPF executed an interest rate swap to fix approximately 25% of FPF s leverage cost for 10 years. 6 The swap added 0.03% of return during the first quarter. Figure 1. Performance (%) as of 3/31/15 Since Quarter YTD 1 Year Inception Fund Performance NAV Share Price Index Performance Blended Index Discount to NAV Distribution Rate 7 FPF continued its strategy of maintaining a focus on income while aiming to better protect investors against downside risks that could result from an increase in interest rates. 8 Stonebridge Advisors LLC, the fund s sub-advisor, accomplished this with the use of fixed-to-floating rate securities, shorter duration fixed-for-life securities and higher coupon securities that tend to be more defensive as rates rise. Although this lower duration strategy may hinder Stonebridge s ability to outperform in a low-rate environment, such as the one we experienced in 2014 and the early part of 2015, they believe it is in investors best interest to stay the course and will continue to attempt to protect portfolio valuation in a rising rate environment. FPF s weighted average duration as of March 31, 2015, without considering leverage but including the swap, was 4.11 years, and the duration including the leverage was 5.99 years. The duration of the blended index at quarter-end was 5.28 years. As per the prospectus, Stonebridge seeks to maintain, under normal market conditions, a duration excluding the effects of leverage, of between three and eight years, so the fund remains below the mid-point of its allowed range on an unleveraged basis. 1Q15 General Market Recap The preferred and hybrid securities markets experienced a strong start to 2015 driven by increasingly accommodative policy amongst central banks around the world, and supported by global interest rates that remain near historic lows. The Federal Reserve continues to be the largest driver of volatility followed by concerns of slowing growth around the world, geopolitical risks, and commodity prices. These macroeconomic concerns have been mitigated by increasing investor demand for yield in conjunction with improving credit fundamentals and market technicals within the preferred and hybrid space. As shown in Figure 2, the retail market, as measured by the BofA Merrill Lynch Fixed Rate Preferred Securities Index, P0P1, earned a total return of 3.38% during the first quarter while the institutional market, as measured by the Bank of America Merrill Lynch U.S. Capital Securities Index, C0CS, earned 2.59%. NAV Share Price FPF -8.10% 8.68% $24.44 $22.46 Inception date of the fund is 5/23/13. Returns are average annualized total returns, except those for periods of less than one year, which are cumulative. Performance data quoted represents past performance. Past performance is not a guarantee of future results and current performance may be higher or lower than performance quoted. Investment returns and principal value will fluctuate and shares, when sold or redeemed, may be worth more or less than their original cost. You can obtain performance information which is current through the most recent month-end by visiting 1

2 Figure 2. Hybrid Preferred Total Return Performance Relative to Other Indices Index Ticker Avg. Effective Rating 9 Duration 4Q14 FY2014 1Q2015 BofA Merrill Lynch Fixed Rate Preferred Securities P0P1 BBB % 15.44% 3.38% BofA Merrill Lynch US Capital Securities C0CS BBB % 8.93% 2.59% BofA Merrill Lynch Contingent Capital - Hedged COCO BB % 5.80% 4.71% BofA Merrill Lynch Contingent Capital - Cur. Adj. COCO BB % 1.63% 1.29% BofA Merrill Lynch US Corporate C0A0 A % 7.51% 2.26% BofA Merrill Lynch US Cash Pay High Yield J0A0 B % 2.45% 2.53% BofA Merrill Lynch Current 10-Yr US Treasury GA10 AAA % 10.72% 2.60% BofA Merrill Lynch Current 30-Yr US Treasury GA30 AAA % 29.43% 4.99% BofA Merrill Lynch US Mortgage Backed Securities M0A0 AAA % 6.07% 1.00% BofA Merrill Lynch US Municipal Securities U0A0 AA % 9.78% 1.09% BofA Merrill Lynch All US Convertibles ex Mandatory V0A0 1.29% 9.33% 2.97% S&P 500 SPX 4.39% 11.39% 0.44% Source: Stonebridge Advisors LLC, BofA Merrill Lynch Research as of 3/31/15. This example is for illustrative purposes only and not indicative of the Fund. Past performance is no guarantee of future results. Strong performance within the preferred and hybrid markets during the first quarter was driven primarily by strength in government debt markets worldwide. During the quarter, we saw increasing quantitative easing in Europe, China and Japan. Perhaps the biggest change was in Europe, where the European Central Bank began buying debt securities, driving long-dated peripheral government bonds to all-time highs. The resulting low yields on government securities throughout Europe, and the relatively higher yields attainable in the U.S. Treasury market, resulted in increased overseas demand for U.S. Treasuries. Additionally, the U.S. market was supported by increasing sentiment that quantitative easing in the U.S. would last longer than anticipated as consensus expectations for the first Federal Reserve rate hike were delayed from June until September The preferred and hybrid securities markets were additionally supported by increasing corporate creditworthiness in the U.S. During the quarter, the biggest U.S. banks received both stress test and Comprehensive Capital Analysis and Review ( CCAR ) results from the Federal Reserve. 10 Although the U.S. subsidiaries of Banco Santander and Deutsche Bank did not receive approval for their capital plans, there were no banks that received outright objections from the Federal Reserve. Generally speaking, bank revenue trends and margins remain weak because of historically low interest rates, but the stress test results confirmed the stable and improving strength of bank balance sheets. The majority of non-financial and industrial issuers in the preferred and hybrid securities markets have reduced leverage, credit quality has continued to improve, and capital levels are stable with most banks now comfortable enough to increase dividends and share buybacks. Investment Outlook Stonebridge believes historically low interest rates globally, relatively attractive yields on preferreds and hybrid securities, and positive issuer credit fundamentals will continue to support the preferred and hybrid securities market in Long-term bond yields in developed economies are at historically low levels due to accommodative central bank actions and tepid global economic activity. Foreign demand for relatively attractive U.S. Treasuries has kept long-term bond yields low. This has increased the attractiveness of U.S. dollar preferred and hybrid securities. Yield spreads of preferred and hybrid securities relative to both U.S. Treasuries and other credit spread products remain wider than historical averages, which should help drive positive performance in the asset class (Figures 3 & 4). Additionally, while preferred and hybrid securities credit spreads in general have tightened due to the improvement and stabilization of issuers credit quality, Stonebridge believes that credit spreads have room to tighten further in the industries that are most prevalent within the preferred market as credit fundamentals continue to improve. Although Stonebridge believes current market conditions are favorable for preferred and hybrid securities, they have chosen to take a conservative stance as it relates to potential interest rate risk by increasing exposure to less interest rate sensitive securities. Stonebridge currently favors structures with good rate protection and high current yields, such as 10 year non-callable fixed-to-floats with high reset rates. Fixed-rate securities with high current yields, in which Stonebridge believes the issuer could refinance at a substantially lower cost of capital and that have attractive yield to-calls (varies depending on the call date) are also attractive, as well as legacy tier 1 capital securities issued by banks that are likely to be called in the next few years that are trading at discounts or have attractive yields. 11 With the potential for rate volatility, Stonebridge believes it is prudent to maintain durations shorter than the blended index, particularly if it can be done while paying income comparable to the blended index yield. 2

3 Figure 3. Comparison of Preferred and Hybrid Securities to Other Fixed-Income Asset Classes Index Ticker Avg. Rating Current Yield (%) OAS 12 Effective Duration BofA Merrill Lynch Fixed Rate Preferred Securities P0P1 BBB BofA Merrill Lynch Adjustable Rate Preferred Securities P0A0 BBB N/A N/A BofA Merrill Lynch US Capital Securities C0CS BBB BofA Merrill Lynch US Corporate C0A0 A BofA Merrill Lynch US Cash Pay High Yield J0A0 B BofA Merrill Lynch Current 10-Yr US Treasury GA10 AAA 1.98 N/A 9.09 BofA Merrill Lynch Current 30-Yr US Treasury GA30 AAA 2.51 N/A BofA Merrill Lynch US Mortgage Backed Securities M0A0 AAA BofA Merrill Lynch US Municipal Securities U0A0 AA Source: Stonebridge Advisors LLC, BofA Merrill Lynch Research as of 3/31/15. This example is for illustrative purposes only and not indicative of the Fund. Past performance is no guarantee of future results. Figure 4. Historical Yield Spread of Preferred Securities vs. 10-Year Treasury Preferred spreads over Treasuries are above historical averages, offering the potential for capital appreciation along with an attractive level of current income % 14.00% 12.00% 10.00% 8.00% 6.00% 4.00% P0P1 GA10 Average Spread bps 12/31/1997 3/31/2015 Average Spread bps 12/31/1997 7/31/2007 Start of Credit Crisis Average Spread bps 7/31/2007 3/31/2015 Current Spread 406 bps 6.04% 2.00% 1.98% 0.00% Preferred Securities are represented by the BofA Merrill Lynch Fixed-Rate Preferred Securities Index (P0P1). 10-Year Treasuries are represented by the BofA Merrill Lynch Current 10-Year U.S. Treasury Index (GA10). Source: Merrill Lynch, Bloomberg, Stonebridge Advisors LLC as of 3/31/15. This example is for illustrative purposes only and not indicative of the Fund. Past performance is no guarantee of future results. 3

4 Investment Objective/Strategy First Trust Intermediate Duration Preferred & Income Fund is a non-diversified, closed-end management investment company. The Fund's primary investment objective is to seek a high level of current income. The Fund has a secondary objective of capital appreciation. The Fund seeks to maintain, under normal market conditions, a duration excluding the effects of leverage, of between three and eight years. Under normal market conditions, the Fund will invest at least 80% of its Managed Assets in a portfolio of preferred and other income-producing securities. The Fund also will invest at least 25% of its Managed Assets in the group of industries that are part of the financials sector as classified under the Global Industry Classification Standards developed by MSCI, Inc. and Standard & Poor's, which is currently comprised of banks, diversified financials, real estate (including real estate investment trusts) and insurance industries. Under normal market conditions, the Fund will seek to invest in a portfolio of securities that has an average weighted investment grade credit quality. The Fund, for enhanced income potential, will also invest in below investment-grade securities. These securities are commonly referred to as junk or high-yield securities and are considered speculative with respect to the issuer's capacity to pay interest and repay principal. Performance Summary as of 3/31/2015 Cumulative Total Returns Period Share Price NAV 3 Months 0.35% 3.84% Year to Date 0.35% 3.84% 1 Year 11.21% 10.98% Average Annual Total Returns Period Share Price NAV 3 Years N/A N/A 5 Years N/A N/A Since Inception (5/23/13) 2.49% 9.95% Total return is the combination of reinvested dividend income and reinvested capital gains distributions, at prices obtained by the Dividend Reinvestment Plan, if any, and changes in the NAV and Share Price. The NAV total return takes into account the Fund s total annual expenses and does not reflect sales load. Performance would have been lower if a sales load would have been applied. Performance data quoted represents past performance. Past performance is not a guarantee of future results and current performance may be higher or lower than performance quoted. Investment returns and principal value will fluctuate and shares when sold, may be worth more or less than their original cost. The NAV represents the Fund s net assets (assets less liabilities) divided by the Fund s common shares outstanding. Fund shares are purchased and sold on an exchange at their share price rather than NAV, which may cause the shares to trade at a price greater than NAV (premium) or less than NAV (discount). Risks and Considerations The fund is subject to risks, including the fact that it is a non-diversified closed-end management investment company. Shares of closed-end investment companies frequently trade at a discount from their net asset value. Investment return and market value of an investment in the fund will fluctuate. Shares, when sold, may be worth more or less than their original cost. Preferred/hybrid and debt securities in which the fund invests are subject to various risks, including credit risk, interest rate risk, and call risk. Credit risk is the risk that an issuer of a security will be unable or unwilling to make dividend, interest and/or principal payments when due and that the value of a security may decline as a result. Credit risk may be heightened for the fund because it invests in below investment grade securities, which involve greater risks than investment grade securities, including the possibility of dividend or interest deferral, default or bankruptcy. Interest rate risk is the risk that the value of fixed-rate securities in the fund will decline because of rising market interest rates. Call risk is the risk that performance could be adversely impacted if an issuer calls higher-yielding debt instruments held by the fund. Because the fund is concentrated in the financials sector, it will be more susceptible to adverse economic or regulatory occurrences affecting this sector, such as changes in interest rates, loan concentration and competition. Investment in non-u.s. securities is subject to the risk of currency fluctuations and to economic and political risks associated with such foreign countries. Use of leverage can result in additional risk and cost, and can magnify the effect of any losses. The risks of investing in the fund are spelled out in the prospectus, shareholder report and other regulatory filings. 4

5 Footnotes: 1 Leverage is a technique where a fund s manager borrows assets at one rate and invests the proceeds from the borrowed assets at another rate, seeking to increase yield and total return. Use of leverage can result in additional risk and cost, and can magnify the effect of any losses. 2 $1000 par ( institutional ) securities are issued and trade in denominations of $1000. They are typically traded over the counter (OTC), and generally have income accrued daily separate from the market price, similar to corporate bonds. 3 A fixed-to-floating rate security has a coupon rate that is fixed for a certain period of time (typically five, ten or thirty years from the time of issuance), after which the coupon resets at a floating rate based on a spread over the security s benchmark (typically 3-month LIBOR). 4 $25 par ( retail ) securities are issued and trade in denominations of $25. They are generally listed and traded on the NYSE, have accrued income embedded within the market price, and coupons are only received if security is owned on record date, similar to common stocks. 5 A variable-rate security is one with an interest rate (coupon) that changes on a periodic basis, usually tied to an outside indicator, such as LIBOR. Variable-rate securities often have a floor (and ceiling) for a given dividend rate. 6 Swaps are the exchange of one security for another in order to take advantage of comparative advantages in interest rates. 7 Distribution rates are calculated by annualizing the most recent distribution paid or declared through the end of the quarter and then dividing by the quarter-end market price. The distribution consists of the sum of net investment income, net realized short-term capital gains, net realized long-term capital gains, and return of capital. Distribution rates may vary. Any distribution adjustment will not be reflected until after the declaration date for the next distribution. See the fund's 19a-1 Notices, if any, located under the "News & Literature" section of the website for estimates of distribution sources. Final determination of the source and tax status of all distributions paid in the current year will be made after year-end. 8 Duration/Interest rate risk is a measure of a security s sensitivity to interest rate changes that reflects the change in a security s price given a change in yield. 9 A credit rating is an assessment provided by a nationally recognized statistical rating organization (NRSRO), including Standard & Poor's Rating Group, Moody's Investors Service, Inc., and Fitch Ratings, of the creditworthiness of an issuer with respect to debt obligations. Ratings are measured on a scale that generally ranges from AAA/Aaa (highest) to D/C (lowest). Investment grade is defined as those issuers that have a long-term credit rating of BBB-/Baa3 or higher. 10 Comprehensive Capital Analysis and Review evaluates the capital planning processes and capital adequacy of the largest U.S.-based bank holding companies, including the firms' planned capital actions such as dividend payments and share buybacks and issuances. 11 Tier 1 is a term used to describe the capital adequacy of a bank from a regulator s point of view. Tier I capital is core capital, this includes equity capital and disclosed reserves. 12 Option-Adjusted Spread is a measurement of the spread of a fixed-income security rate and the risk-free rate of return, which is adjusted to take into account an embedded option. Index Definitions: P0P1 BofA Merrill Lynch Fixed Rate Preferred Securities Index tracks the performance of fixed-rate US dollar denominated preferred securities issued in the US domestic market. C0CS BofA Merrill Lynch US Capital Securities Index a subset of the BofA Merrill Lynch US Corporate Index including all fixed-to-floating rate, perpetual callable and capital securities. C0A0 BofA Merrill Lynch US Corporate Index tracks the performance of US dollar denominated investment grade corporate debt publicly issued in the US domestic market. J0A0 BofA Merrill Lynch US Cash Pay High Yield Index tracks the performance of US dollar denominated below investment grade corporate debt, currently in a coupon paying period, that is publicly issued in the US domestic market. GA10 BofA Merrill Lynch Current 10-Year US Treasury Index is a one-security index comprised of the most recently issued 10-year US Treasury bond. GA30 BofA Merrill Lynch Current 30-Year US Treasury Index is a one-security index comprised of the most recently issued 30-year US Treasury bond. M0A0 BofA Merrill Lynch US Mortgage Backed Securities Index tracks the performance of US dollar denominated fixed rate and hybrid residential mortgage pass-through securities publicly issued by US agencies in the US domestic market. U0A0 BofA Merrill Lynch US Municipal Securities Index tracks the performance of US dollar denominated investment grade tax-exempt debt publicly issued by US states and territories, and their political subdivisions, in the US domestic market. V0A0 BofA Merrill Lynch All US Convertibles ex Mandatory Index tracks the performance of convertible securities of all corporate sectors with a par amount of $25 million or more and a maturity of at least one year and excludes preferred equity redemption stocks and converted securities. SPX S&P 500 Index an unmanaged index of 500 stocks used to measure large-cap U.S. stock market performance. COCO BofA Merrill Lynch Contingent Capital Index tracks the performance of all contingent capital debt publicly issued in the major domestic and Eurobond markets, including investment-grade and sub-investment-grade issues. P0A0 BofA Merrill Lynch Adjustable Rate Preferred Securities Index tracks the performance of adjustable-rate US dollar denominated preferred securities issued in the US domestic market. Indexes are unmanaged and an investor cannot invest directly in an index. 5