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First Trust Intermediate Duration Preferred & Income Fund Update
4th Quarter 2014
Stonebridge Advisors LLC Fund Commentary
FUND POSITIONING AND PERFORMANCE
The First Trust Intermediate Duration Preferred & Income Fund ("FPF") produced a
total return based on net asset value (NAV ) for the fourth quarter of 2014 of
1.67% versus a total return of the blended index, a 50/50 blend of the BofA
Merrill Lynch Fixed Rate Preferred Securities Index (P0P1) and the BofA Merrill
Lynch US Capital Securities Index (C0CS) of 1.65%. The key drivers of the small
outperformance during the fourth quarter were an overweight in Contingent
Convertible Securities (CoCo's) and the use of leverage.(1,2) FPF had a 10.77%
weighting in CoCo's and the securities held produced a total return in Q4 of
1.92%, while the blended index has no CoCo weighting. It should be noted that
the BofA Merrill Lynch Contingent Capital Index (COCO) had a total return for
the quarter of 1.11% so the security selection in FPF was a positive factor in
performance. Leverage during the fourth quarter in FPF averaged close to 31% and
added 0.44% of return during the period.
Detractors of performance during the fourth quarter were an overweight in both
institutional securities, which underperformed retail securities, and fixed-
to-floaters, which underperformed longer duration fixed for life securities.(3,
4,5,6) Additionally, the interest rate hedge we utilized for part of the fourth
quarter had a total return of -0.11%. The interest-rate hedge, used to manage
duration, consisted of positions in Treasury futures and options on treasury
futures.(7) This hedge has been eliminated until we have more conviction on
U.S. Treasuries and interest rates in general.
FIGURE 1. PERFORMANCE (%) AS OF 12/31/14
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Since
Quarter YTD 1 Year Inception
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Fund Performance
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NAV 1.67 12.81 12.81 8.97
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Share Price 8.44 17.08 17.08 2.65
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Index Performance
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Blended Index 1.65 12.15 12.15 4.85
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Discount Share
to NAV Distribution NAV Price
Rate(8)
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FPF -4.90% 8.59% $23.88 $22.71
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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 FTPORTFOLIOS.COM.
FPF continued its strategy of maintaining income while aiming to better protect
investors against downside that could result from an increase in interest rates.
This was accomplished with the use of fixed-to-floaters, shorter duration
fixed-for-life securities and higher coupon securities that tend to be more
defensive in a rate rise. Although this lower duration strategy may hinder the
fund's ability to perform in a lower interest rate environment such as the one
experienced through all of 2014 and the early part of 2015, we believe it is in
fund investors' best interest to stay the course and do our best to protect in a
rising rate environment. FPF's weighted average duration as of December 31,
2014, without considering leverage, was 4.71 years, and the duration including
the leverage was 6.88 years. The blended index's duration at year-end was 5.54
years. We manage FPF's duration within a band of 3 to 7 years.
It is worth noting that in January, First Trust and Stonebridge executed a swap
to fix approximately 25% of FPF's leverage for 10 years.(9) We look at this low
interest rate environment combined with the possible Federal Reserve move to
raise short-term interest rates sometime in the next 6 to 18 months as an
opportunistic time to protect some of the leverage from future rising rates.
4Q14 GENERAL MARKET RECAP
The preferred and hybrid securities markets were strong performers during the
fourth quarter and 2014 despite volatility throughout financial markets
worldwide. Preferred and hybrid securities earned 15.44% and 8.93%,
respectively, for the year-end 2014, and 2.72% and 0.59% during the fourth
quarter, according to the BofA Merrill Lynch Preferred and Hybrid Indices P0P1
and C0CS, as shown in Figure 2.
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First Trust Portfolios L.P. o First Trust Advisors L.P. o 1-800-988-5891
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First Trust Intermediate Duration Preferred & Income Fund Update
FIGURE 2. HYBRID PREFERRED TOTAL RETURN PERFORMANCE RELATIVE TO OTHER INDICES
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AVG. EFFECTIVE
INDEX TICKER RATING(10) DURATION 4Q14 FY2014
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BOFA MERRILL LYNCH FIXED RATE PREFERRED SECURITIES P0P1 BBB2 5.72 2.72% 15.44%
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BOFA MERRILL LYNCH US CAPITAL SECURITIES C0CS BBB2 5.36 0.59% 8.93%
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BofA Merrill Lynch Contingent Capital COCO BB1 4.56 -0.38% 1.63%
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BofA Merrill Lynch US Corporate C0A0 A3 6.96 1.43% 7.51%
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BofA Merrill Lynch US Cash Pay High Yield J0A0 B1 4.49 -1.05% 2.45%
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BofA Merrill Lynch Current 10-Yr US Treasury GA10 AAA 8.96 3.56% 10.72%
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BofA Merrill Lynch Current 30-Yr US Treasury GA30 AAA 20.55 10.12% 29.43%
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BofA Merrill Lynch US Mortgage Backed Securities M0A0 AAA 4.00 1.79% 6.07%
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BofA Merrill Lynch US Municipal Securities U0A0 AA3 6.85 1.33% 9.78%
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BofA Merrill Lynch All US Convertibles ex Mandatory V0A0 1.29% 9.33%
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S&P 500 SPX 4.92% 13.68%
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Source: Stonebridge Advisors LLC, BofA Merrill Lynch Research as of 12/31/14.
This example is for illustrative purposes only and not indicative of the Fund.
Past performance is no guarantee of future results.
Performance of the preferred and hybrid markets was supported by strong rates, a
stable U.S. economy and the continued fundamental improvement of financial
companies. Even as the Federal Reserve reduced quantitative easing, ending
additional asset purchases in October 2014, the U.S. Treasury market experienced
positive performance, driven by lower rates around the globe and a strong U.S.
economy. The performance of the Treasury market surprised most, substantially
surpassing even the lowest forecasts of the 50+ economists surveyed by
Bloomberg, as shown in Figure 3. Improvements of the U.S. economy were the
strongest during the fourth quarter, highlighted by the announcement of a third
quarter GDP number revised up to 5%, representing the first two quarters of
consecutive 4% growth since 2003. Additionally, the job market experienced its
strongest growth in 15 years with unemployment ending the year at 5.4%, the
lowest since mid-2008.
FIGURE 3. TREASURY RATES AND EXPECTATIONS
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LOWEST 12/31/14 EXPECTATION MEDIAN 12/31/14 EXPECTATION
SECURITY 12/31/13 RATE AS OF 12/31/13(11) AS OF 12/31/13(11) 12/31/14 RATE
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U.S. 10-YEAR TREASURY 3.04% 2.50% 3.44% 2.17%
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U.S. 30-YEAR TREASURY 3.96% 3.50% 4.25% 2.75%
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Source: Stonebridge Advisors LLC, U.S. Department of the Treasury, Bloomberg
Duration was the primary driver of performance during both the quarter and the
year with the move in the U.S. Treasuries driving the substantial outperformance
of long duration securities. This also caused substantial outperformance of the
retail preferred securities market, which is longer duration due to a much
higher percentage of fixed-rate securities. Performance during 2014 was also
supported by expectations that the yield curve will flatten, and analysts'
further reducing expectations for the long-end of the curve.
The second half of the year, and particularly December, were volatile periods
driven by increasing macroeconomic and geopolitical risk. There remain many
obstacles plaguing the markets, including concerns about global growth and the
direct and indirect impacts of the sell-off in oil. Credit also became a bigger
concern with one-off credit events occurring during the year and with a bigger
concern about whether the stresses in U.S. high yield energy could cause the
next default cycle. Risk assets were sharply lower in December, particularly in
Europe, and CoCo's reached the lows of the year. Negative drivers were combatted
not only by a strong U.S. economy, but also by commitment and actions by
international central banks as they continued to increase accommodative policy.
The fourth quarter saw the announcement of increased stimulus from Japan, China
and Europe, bolstering the bond markets and driving the U.S. equity markets to
all-time highs.
The market remains supported by a strong U.S. economy, stimulus from central
banks around the world, and flows into the market as investors continue to seek
yield and take advantage of the relative attractiveness of the preferred and
hybrid securities markets.
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First Trust Portfolios L.P. o First Trust Advisors L.P. o 1-800-988-5891
www.ftportfolios.com
First Trust Intermediate Duration Preferred & Income Fund Update
MARKET OUTLOOK
Coming off a tremendous year for preferred and hybrid securities, in which the
low interest rate environment supported the bullish move higher, we think 2015
will see a market in which security selection is paramount. We believe it will
be another positive year for preferreds and hybrids, but active management and
relative value trades based on macroeconomic trends and events, credit quality,
security structure, and supply will be where investors can add alpha.(12)
With central banks around the world maintaining an accommodative stance, we
anticipate interest rates will remain low globally in 2015. The market is
anticipating the Federal Reserve to begin to raise rates at some point in 2015,
and this may cause some intermittent rate volatility. Preferred securities will
likely feel some of that volatility, especially if we see outflows from large
ETFs and mutual funds. Nonetheless, yield spreads to Treasuries remain wide to
historical averages and other credit spread products, which should help mitigate
this risk and support the market.
Credit spreads in general have tightened as the credit quality of issuers within
preferred and hybrid securities have improved or remained stable. Nonetheless,
there continue to exist pockets of credit risk within the market which have
created some volatility in 2014 that need to be monitored in 2015. An active
approach to investing will be the best way to attempt to avoid any credit events
that arise.
Security structure continues to be an important factor within the preferred
market. There are so many variations in how preferreds and hybrids are
structured that investors must be familiar with every type of coupon structure,
security characteristic and covenant to make intelligent investment decisions.
We currently favor structures with good rate protection and high current yields,
such as 10 year non-call fixed-to-floats with high reset rates.
There will be more supply from the financial sector in 2015, both in the U.S.
and Europe with the majority coming from the European banks. Estimates for
issuance from the U.S. and European banks are around $50-100 billion in
Additional Tier 1 (AT1) eligible preferred securities and CoCo's.(13) With a
substantial amount of new issuance on the horizon, we believe there is the
potential for short term volatility in the market and specific issuers,
depending on the size and structure of new issues relative to outstanding
securities trading in the secondary market. Successfully navigating an increase
in supply will require experience and knowledge of the preferred and hybrid
markets in our opinion.
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First Trust Portfolios L.P. o First Trust Advisors L.P. o 1-800-988-5891
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First Trust Intermediate Duration Preferred & Income Fund Update
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 12/31/2014
CUMULATIVE TOTAL RETURNS
PERIOD SHARE PRICE NAV
3 Months 8.44% 1.67%
Year to Date 17.08% 12.81%
1 Year 17.08% 12.81%
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) 2.65% 8.97%
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.
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First Trust Portfolios L.P. o First Trust Advisors L.P. o 1-800-988-5891
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First Trust Intermediate Duration Preferred & Income Fund Update
FOOTNOTES:
1 Contingent Convertible securities (CoCo's) are a specific type of security
similar to traditional convertible bonds. Unlike traditional convertible
bonds, the possibility of converting a CoCo bond to equity is "contingent"
and will occur only in the case of a specific event that can be different
depending on the particular need of an issuer.
2 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.
3 $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.
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 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).
6 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.
7 Futures are a financial contract obligating the buyer to purchase an asset
(or the seller to sell an asset) at a predetermined future date and price.
8 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.
9 Swaps are the exchange of one security for another in order to take
advantage of comparative advantages on interest rates.
10 The ratings are by Standard & Poor's. A credit rating is an assessment
provided by a nationally recognized statistical rating organization (NRSRO),
of the creditworthiness of an issuer with respect to debt obligations.
Ratings are measured on a scale that generally ranges from AAA (highest) to
D (lowest). Investment grade is defined as those issuers that have a
long-term credit rating of BBB- or higher.
11 Yield forecast of 50+ economists surveyed by Bloomberg.
12 Alpha is an indication of how much an investment outperforms or
underperforms on a risk-adjusted basis relative to its benchmark. The higher
the Alpha, the better has been the risk-adjusted performance.
13 Additional Tier 1 instruments are required to absorb losses on a going
concern basis, either through a write down or conversion into ordinary
shares.
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.
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. 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 - The S&P 500 Index is 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.
Indexes are unmanaged and an investor cannot invest directly in an index.
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First Trust Portfolios L.P. o First Trust Advisors L.P. o 1-800-988-5891
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