FPF's Preferred Securities Strategy in a Shifting Rate Environment: Balancing Yield and Sustainability

In a 2025 market marked by anticipated Federal Reserve rate cuts and economic normalization, income-focused investors are increasingly scrutinizing the trade-offs between preferred securities and high-yield bonds. The First Trust Intermediate Duration Preferred & Income Fund (FPF) has positioned itself as a compelling alternative to traditional high-yield vehicles, leveraging its focus on preferred securities to generate attractive yields. However, its sustainability and sector-specific risks demand careful evaluation.

Yield Advantages: Preferred Securities vs. High-Yield Bonds

FPF's 8.82% distribution rate and 9.62% total return on NAV over the past 12 months underscore its appeal in a low-volatility, income-centric environment. Preferred securities, which form the backbone of FPF's portfolio, benefit from a stabilizing long-rate environment and short-term rate cuts, as these conditions enhance the relative value of fixed-dividend instruments. By contrast, high-yield bonds, while offering elevated yields (7.5% for U.S. corporates and 5.7% for European corporates as of late 2024), face challenges in yield spreads. Morningstar notes that these spreads are historically narrow, compressing the margin of safety for investors.

FPF's edge lies in its lower volatility compared to equities and its ability to outperform broader fixed-income indices. For instance, its 8.76% yield exceeds the 6.9% yield of the VanEck Preferred Securities ex Financials ETF (PFXF), which excludes financial sector exposure. This highlights FPF's broader market access, including banking sector preferreds, which historically outperform post-rate cuts. However, this concentration also introduces sector-specific risks, as discussed below.

Distribution Sustainability: A Double-Edged Sword

While FPF's monthly distributions of $0.1375 per share (8.87% yield based on market price) appear robust, its payout ratio of 107.84% raises red flags. This indicates the fund is distributing more in dividends than it earns, a practice that could strain long-term sustainability. Recent data shows a six-month payout ratio of 0.00%, suggesting inconsistent earnings coverage. Such volatility contrasts with high-yield bonds, which, despite lower yield spreads, benefit from stronger credit fundamentals, including low default rates and strong interest coverage ratios. Morgan Stanley notes that these fundamentals remain resilient.

FPF's management strategy emphasizes maintaining stable distributions to support its market price and NAV discount/premium. However, this approach relies heavily on short-term capital gains or return of capital to fund payouts, which may not be reliable in a prolonged rate-cut environment. Investors must weigh FPF's income consistency against its structural payout challenges.

Financial Sector Exposure: Opportunity and Risk

FPF's significant exposure to banking sector preferred securities positions it to capitalize on rate cuts, which historically boost financial sector returns by 7.3% in the six months following Fed easing cycles. Lower rates reduce borrowing costs for banks, enhancing their profitability and, by extension, the value of their preferred securities. However, this concentration exposes the fund to regulatory and macroeconomic risks.

For example, potential deregulatory shifts in 2025, including relaxed capital requirements and climate risk rules, could increase sector volatility. Additionally, geopolitical tensions and cybersecurity threats pose systemic risks to financial institutions. In contrast, PFXF's exclusion of financials offers diversification but sacrifices the sector's rate-sensitive upside. FPF's investors must navigate this trade-off between yield potential and sector-specific vulnerabilities.

Conclusion: A Strategic, Not Universal, Fit

FPF's preferred securities strategy offers a unique niche in a shifting rate environment, combining elevated yields with lower volatility than high-yield bonds. Its performance in 2025 will hinge on the Fed's easing trajectory and the resilience of the banking sector. However, its payout sustainability and sector concentration necessitate a cautious approach. For investors prioritizing income stability and willing to accept moderate volatility, FPF remains a viable option. For those seeking broader diversification or stronger credit fundamentals, high-yield bonds or ex-financial preferreds like PFXF may offer a more balanced profile.

In the end, FPF's positioning reflects the broader tension between yield maximization and risk management-a tension that will define income investing in 2025 and beyond.