- RFI is an actively managed, unlevered CEF focusing on U.S. REITs.
- The fund mostly invests in high-quality, low-risk assets, which reduces volatility and minimizes losses during market downturns.
- RFI has performed particularly well during the coronavirus outbreak, outperforming its index and all other REIT CEFs.
- RFI is a lower-risk, higher-reward investment opportunity, and of particular relevance during these volatile times.
Author's note: This article was initially released to CEF/ETF Income Laboratory members on April 7, 2020.
Eight months ago, I wrote about the Cohen & Steers Total Return Realty Fund (NYSE:RFI), which I believed to be a particularly strong, lower-risk REIT CEF, due to its diversified real estate holdings, market-beating total shareholder returns, strong 9.50% distribution yield, and no use of leverage. This last point is of particular importance during market downturns, as leverage amplifies losses, and can prove particularly ruinous if valuations collapse, as happened with most MLP CEFs.
Since the writing of that article, RFI has outperformed its index and all industry peers on a NAV basis, but only its peers on a price basis, as discounts have widened. RFI's comparatively strong performance was a boon to investors, most of whom have almost certainly seen significant losses in their portfolio. RFI also outperformed most of its industry peers on a leverage-adjusted basis, at least by my calculations; so it seems that the fund is able to generate some alpha, great news for shareholders once again.
Moving forward, I expect RFI to continue outperforming during market downturns, underperform during bull markets, slightly underperform most CEFs in the long term, but offer stronger risk-adjusted returns than its peers. RFI is an outstanding investment opportunity, and is particularly well-suited for more risk-averse income investors and those wishing to minimize their losses during market downturns.
As a final point, as the article was originally published close to a month ago, I decided to re-check these figures. RFI remains the best-performing CEF during the downturn, and has recovered quite a bit of ground in the past month.
- Sponsor: Cohen & Steers
- Distribution Yield: 6.80%
- Expense Ratio: 0.89%
- Total Returns (NAV) CAGR since Inception: 10.0%
- Discount to NAV: 7.42%
- Holdings: 11
Fund Overview - Lower-Risk, High-Quality U.S. REIT CEF
RFI is an unlevered CEF focusing on common and preferred U.S. REIT securities. Like the vast majority of CEFs, RFI is actively-managed, so asset allocation and ultimately returns are strongly dependent on management's decisions, capabilities, and the fund's overall investment strategy. RFI's investment manager, Cohen & Steers, has a decades-long track record of market-beating performance in several industry segments, including real estate, income securities, and real assets, so investors can be somewhat assured that their money is in good hands.
RFI's overall asset allocation strategy, as that of the company's other REIT funds, is generally quite conservative. The fund focuses on high-quality U.S. REITs, and tends to be overweight lower-risk industry segments, including infrastructure, apartments and data centers. RFI's holdings tend to outperform during market downturns, minimizing losses during these, a boon to the fund and its shareholders.
As a quick example of the above, RFI's three largest holdings are American Tower Corporation (AMT), Prologis (PLD), and Equinix (EQIX). These three REITs have performed significantly better than the industry and equities market average during the past downturn, generally outperforming these by double-digit figures, outstanding results:
RFI also invests in some more speculative securities and sectors, including shopping centers, but these only comprise a small portion of the fund's assets. The fund's overall asset allocation strategy ensures that the fund is reasonably well-diversified across industry segments, minimising portfolio risk and volatility, but tilted towards lower-risk higher-quality assets, furthering the same. RFI also invests in preferred shares, currently accounting for 14% of the fund's total holdings, once again reducing portfolio risk and volatility, but slightly decreasing returns.
(Source: RFI Factsheet)
RFI, as mentioned previously, uses no leverage, something quite rare for a CEF, and something that, once again, serves to reduce portfolio risk and volatility, minimizing shareholder losses during market downturns.
RFI's high-quality well-diversified holdings, preferred shares investments, and lack of leverage, combine to create a lower-risk fund, which should significantly outperform during market downturns, boosting long-term shareholder returns.
Performance Analysis - Market-Beating Shareholder Returns - Lower Losses During Downturns
RFI slightly outperforms most relevant industry indexes and peers during all relevant time periods, and moderately outperforms during market downturns. RFI's overall risk-return profile is stronger than those of its peers, although these differences are rarely all that large.
RFI's investment manager provides us with the following table summarizing the fund's performance:
(Source: RFI Factsheet)
As can be seen above, RFI consistently outperforms its index on a NAV basis, although performance is a bit more spotty on a price basis. These differences are small, but the outperformance is a bit more impressive considering the fund's investments in preferred shares.
As some of the indexes included above are somewhat obscure, I decided to compare the fund with the Vanguard Real Estate ETF (VNQ), a more common industry benchmark. RFI has, once again, slightly outperformed this index on most relevant timeframes:
(Source: Seeking Alpha - Chart by author)
RFI's performance is particularly strong during market downturns, see how RFI compares to VNQ during the past month and year above. As the current downturn is still ongoing, I thought to see how the fund compared to the index during the past financial crisis. RFI significantly outperformed during and just after the crisis by quite a bit:
RFI's performance seems outstanding, so far at least, although there is one important caveat. RFI's price returns are somewhat more volatile than NAV returns, due to fluctuating discounts and premiums. The fund tends to trade at a discount during market downturns, almost certainly due to bearish market sentiment and investors selling off their shares, which depresses returns during these. As an example, look at RFI's discount and price performance during the financial crisis:
During the crisis, discounts widened, which directly reduced price returns. These were still stronger than comparable index returns, but significantly weaker than NAV returns.
RFI's fluctuating discounts and premiums are obviously a negative for shareholders wishing to divest themselves from the fund during downturns, but they are, conversely, a benefit for shareholders wishing to invest in the fund during the same time. Actively-minded investors, which I believe includes many subscribers to CEF/ETF Income Laboratory, can choose to opportunistically invest in the fund during periods of significant discounts, boosting returns and distributions alike.
RFI's shareholder returns also compare quite favorably to those of its peers. The fund outperforms its peer average during all relevant time frames, and is generally a top-performing fund. During longer time periods, five years and more, the fund underperforms relative to RNP and RQI, two other leveraged REIT CEFs administered by the same company. As mentioned previously, I do believe that RFI should underperform in the very long term compared to its peers, due to the fund's lack of leverage.
As mentioned previously, RFI seems to continue to outperform once you account for the fund's lack of leverage. Now, I can't really calculate this as I would need detailed information about leverage ratios for all of these funds before the recent market downturn, but I can do a rough estimate. CEFs generally have leverage ratios of about 25%, a past article on RQI shows a leverage ratio of 26.4%. If I use the 25% figure, then a leveraged RFI would have returns of the following multiple:
(1) / (1 - 0.25) = 1.33x
Taking into consideration the above multiple, and the table above as well, it seems that RFI generally outperforms its peers even when accounting for the fund's lack of leverage. For example, RFI's NAV performance for the past year was equivalent to -12.84%. A 25% leveraged RFI would have seen returns of about (1.33) * (-12.84%) = -17%. The average industry CEF had performance of -24.51%, meaning that RFI would have still outperformed its peers even if leveraged.
RFI is a lower-risk, higher-return investment fund with a decades-long track-record of market-beating performance, especially during downturns and bear markets.
Distribution Coverage Analysis - Uncovered Distribution
RFI's distribution rate of 9.50% is barely covered at all, with a distribution coverage ratio of 30.9%, very low. RFI is reliant on capital gains and asset sales to fund its distribution, which might prove unadvisable during market downturns. RFI's manager has been able to generate enough capital gains to sustain the fund's distribution without leading to NAV-eroding return-of-capital distributions since inception, if you disregard the current downturn.
To calculate the fund's distribution coverage ratio, I simply dividend the fund's distribution rate over its SEC Yield, which measures the actual income generated by the fund. I also took a quick look at the fund's latest annual report, and the fund's net investment income figures imply a similar distribution coverage ratio.
(Source: RFI Factsheet)
RFI's uncovered distribution is undoubtedly a negative, but not a particularly significant one, at least in my opinion. Investors simply need to be aware of the fact that the fund is reliant on capital gains and appropriate investment decisions to sustain its distribution, both of which have occurred in the past.
I'm currently not expecting a distribution cut, but if market conditions continue to worsen, or if the fund's underlying holdings reduce their distributions, both of which seem possible, then a cut will likely follow.
Discount and Premium Analysis - Reasonable Discount, Smaller than its Peers
RFI currently offers investors a 5.07% discount, smallest in its peer group. The fund is quite a bit cheaper than it has been in the past, with a Z-score of -0.60, but this is, once again, the smallest in its peer group.
RFI offers investors some value, but significantly less than its peers. This is undoubtedly a negative, and does mean that the fund's peers have somewhat of a greater potential for shareholder returns moving forward.
Conclusion - Outstanding Investment Opportunity
RFI's high-quality conservative holdings, time-proven asset allocation strategy, and lack of leverage have led to low-risk, market-beating total shareholder returns in the past and will, I believe, continue to do so in the future. The fund is a particularly strong investment opportunity for more risk-averse income investors, and should perform particularly well during market downturns, as it has during the present one.
Investors looking for higher-risk, higher-reward investment opportunities should almost certainly consider other funds, as RFI's holdings, small discount to NAV, and lack of leverage mean that the fund is likely to underperform during bull markets. Both RQI and RNP have comparable holdings, but greater discounts and use leverage, and should outperform RFI during bull markets and in the very long term, as they have in the past.
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This article was written by
Juan de la Hoz has worked as a fixed income trader, financial analyst, operations analyst, and as an economics professor. He has experience analyzing, trading, and negotiating fixed-income securities, including bonds, money markets, and interbank trade financing, across markets and currencies. He focuses on dividend, bond, and income funds, with a strong focus on ETFs.
Juan is a contributor to the investing group CEF/ETF Income Laboratory which is led by Stanford Chemist. Features of the service include: managed income portfolios (targeting safe and reliable ~8% yields) making use of high-yield opportunities in the CEF and ETF fund space. These are geared toward both active and passive investors of all experience levels. The vast majority of CEF/ETF Income Laboratory holdings are also monthly-payers, for faster compounding and steady income streams. Other features include 24/7 chat, and trade alerts. Learn More.
Analyst’s 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.
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