Cohen & Steers isn't a household name in the finance industry, but this investment shop helped to establish the real estate investment trust, or REIT, industry. It did that by dedicating itself, at least in its early days, to investing in REITs and sponsoring sector-specific funds. So, when I got a request from a reader for some REIT closed-end fund, or CEF, profiles, Cohen & Steers was the easy place to start. The three most notable offerings are Cohen & Steers Quality Income Realty Fund (NYSE:RQI), Cohen & Steers Total Return Realty Fund (NYSE:RFI), and for those seeking something slightly different, Cohen & Steers REIT & Preferred Income Fund (NYSE:RNP).
Sisters, Not Twins
RQI and RFI are very similar CEFs. In fact, the two funds have similar sector breakdowns, similar regional breakdowns, and seven of their top 10 holdings are the same. Interestingly, despite these similarities, the two funds have different objectives. RQI's primary goal is high current income with a secondary objective of capital appreciation. RFI's focus is on a high total return, which of course is a mixture of dividends and capital appreciation.
So, in many ways, these two funds are close siblings. But they aren't twins. And that shows up most prominently in their use of leverage. RQI makes us of it, and RFI does not. So, if you don't like the idea of a fund using leverage, stick to RFI.
Leverage, of course, is both a blessing and a curse. It can help increase distributions in both flat and good markets, allowing RQI to buy more dividend-paying assets and passing on the income it earns above its interest costs. In good markets, meanwhile, capital gains will be augmented by the leverage. However, it's worth noting that RQI's 7.5% distribution yield relative to net asset value is only slightly higher than RFI's 7.3%. So it isn't clear that leverage is really doing that much for RQI's yield.
However, in down markets, losses at RQI get exacerbated. This was on clear display in the second quarter of 2015 when RQI's net asset value, or NAV, fell nearly 11% while RFI's NAV fell roughly 8%. But, in the following two quarters, RQI bested RFI to the upside. In fact, RQI's return was roughly 50% greater in the fourth quarter. Leverage is a big issue you'll want to think about with this pair.
But it isn't as clear cut as the above example may suggest. For example, RQI has better trailing one-, three-, and five-year NAV returns through December. That span was largely positive for REITs. Take the disastrous 2007-2009 period into account, however, by reaching out to 10 years, and it's RFI that has the lead with an annualized total return of around 8.1% compared to RQI's annualized total return of roughly 5.4%. The difference? RFI didn't get hurt as badly during the financial-led recession because it didn't use leverage.
This difference shows up in standard deviation as well. RQI's standard deviation, a measure of price volatility, is higher than RFI's over the trailing three-, five-, and 10-year periods. That makes a great deal of sense, and it's one more example of why leverage is probably the most important difference for investors to consider when comparing these two funds. In fact, the impact of leverage extends to the expense ratio, too. RQI's leverage costs result in an expense ratio of around 1.9%. RFI's expense ratio is a far more subdued 0.94%.
So, if you are looking at these two funds, make a decision about leverage before you look at anything else. That said, both funds are trading at historically wide discounts. RQI's recent discount of around 15% compares to a three-year average of closer to 10%. And RFI's discount of about 11% is notably wider than its three-year average of around 5%. RQI's market yield is around 8.8% and RFI's is around 8.3%. Although there are differences here, they aren't large enough to offset the leverage issue in my eyes.
Now For Something Completely Different...
Cohen & Steers has another CEF with a REIT focus, but it's something of a hybrid offering: Cohen & Steers REIT & Preferred Income Fund. As the name suggests, RNP is a mix of REITs and preferred stocks. It's REIT portfolio is roughly similar to RQI and RFI, which shouldn't be much of a surprise. However, the preferred portfolio is heavily weighted toward banks, which make up about half of the preferred stocks RNP owns. That's likely less by design than it is by default since financials, like banks, are a big part of the preferred market. Insurance, another finance sector, makes up around 22% of the preferred portfolio, so finance in some form accounts for nearly 75% of the preferreds RNP owns.
So, in many ways, this is a REIT and finance fund. And since preferred stocks have some similarities to bonds, you could even consider it something of a balanced offering. It's interesting to note, however, that RNP's standard deviation over the trailing three- and five-year periods are roughly in line with RFI's numbers. Over the trailing 10 years, however, RNP is actually a more volatile offering. What gives? Like RQI, RNP can make use of leverage.
Performance wise, RNP bests RFI based on NAV total return over the trailing three- and five-year periods, but lags it over the trailing decade. That's basically the same dynamic that shows up between siblings RQI and RFI, which, in my mind, begs the question of why even look at RNP?
RNP's recent discount was around 19% compared to a three-year average of around 13%. And the current market yield is roughly 8.6%. So, even here, there's not much to distinguish RNP from the other two REIT CEFs Cohen & Steers offers. Expenses, meanwhile, are around 1.7% of assets, pushed higher by the cost of leverage.
So what should you make of RNP... This one is really a strategic issue. If you want a portfolio that includes preferred stock and REITs, this is a way to do it. It may not be the best way to do it, but it certainly isn't a bad way. And it's easy since the fund is a one-stop shop. Other than that, I'm not the biggest fan.
I lean toward RFI
Having looked all of this over, you've probably figured out that, of this trio, I'm most fond of RFI. It's simple, to the point, and has performed fairly well through good markets and bad... And without the benefits and negatives of using leverage. If you feel strongly that REITs are heading higher, it won't do as well as RQI and probably even RNP. But, if you turn out to be wrong, it will likely hold up better, evening the playing field over the long term.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.