Written by Nick Ackerman, co-produced by Stanford Chemist
Nuveen Diversified Dividend and Income Fund (NYSE:JDD) is as the name would suggest and that is highly diversified. They take a 50/50 balanced approach to investing between stocks and bonds, though are free to move outside these parameters a bit as needed. They also aren't limited to one geographic region, and instead, invest around the globe. That also provides flexibility for the managers to invest where they see opportunity. REITs do play a major role in their investing approach, however.
As I'm looking for opportunities for investments outside the U.S., this fund piqued my interest. The fund's objective is a "high current income and total return."
The parameters they list for investing to achieve this objective are: "1) U.S. and foreign dividend-paying common stocks, 2) dividend-paying common Real Estate Investment Trusts issued by real estate companies, 3) emerging markets sovereign debt, and 4) senior loans. The Fund expects to invest between 40% and 70% of its managed assets in equity security holdings and between 30% and 60% of its managed assets in debt security holdings. Under normal circumstances, the Fund's target weighting is approximately 50% equity and 50% debt."
This type of approach means an investor can have a bit of exposure to almost anywhere in the globe and to almost any type of income-focused investment, though with a heavier emphasis on REITs. REITs themselves are focused on producing income, so is a great fit for this type of portfolio anyway. This makes it a unique approach from other choices on the market. It can also add instant diversification to an investor's portfolio.
This approach can make it a bit similar to Nuveen Real Asset Income and Growth Fund (JRI). JRI is a holding in our Income Generator portfolio at the CEF/ETF Income Laboratory. However, JRI puts less of an emphasis on the fixed-income approach - and more on real estate and infrastructure equities and preferred. Though bond investments aren't with some exposure in the fund.
The fund is on the smaller size with only around $283 million in total managed assets. So a limit order when buying and selling would be appropriate. Additionally, the fund utilizes leverage. This can increase risks relative to a non-levered investment option. Though it can also be beneficial during a rising market. The expense ratio for the fund comes to 1.52% - when including leverage expense this comes to 2.10%.
The leverage currently works out to 29.32%. The leverage cost for the fund was last reported at just 0.85%. The leverage was reduced throughout 2020 as they are currently sitting on $82.9 million. A reduction from the December 31st, 2019 amount of $97.9 million. Though was an increase from their Semi-Annual Report when they had borrowings of $73.4 million.
In that same report, they had shared a bit more on their view of leverage.
The Fund's use of leverage had a negative impact on total return performance during this reporting period. The negative impact of leverage during the brief but severe COVID-19 induced market downturn in March was greater than the positive impact of leverage during the remainder of the reporting period. More specifically, this net negative contribution of leverage was amplified during the market downturn in part because the Fund used proceeds from portfolio sales to pay down borrowings and reduce its elevated leverage ratio, which rose as prices of portfolio securities, including those sold for de-levering purposes, declined. Conversely, as financial markets recovered and asset prices steadied, the Fund gradually increased leverage levels, using proceeds to purchase new portfolio securities at generally higher prices. Management believes, however, that the potential benefits from leverage continue to outweigh the associated increase in risk and total return variability previously described.
Performance - Deep Discount Creating A Potential Opportunity
Last year they made some significant recoveries from the lows they experienced in March 2020. Though the reduction in leverage had hindered some of the recovery that it would have otherwise experienced. This impairment is one of the problems with leveraged funds and when they are forced to deleverage.
However, they reported a total NAV return of -6.37% for the year. On a total return price basis, this worked out to -10.89%. Certainly, not the best result as an investment in most equities focusing on the U.S. market ended up with attractive returns.
That being said, the lagging price has created a bit of an opportunity for investors now. The fund trades at a wide 13.43% discount. Over the last year, this is a bit below the average level - at a 14.96% average. However, now that March 2020 happened almost one year ago, this has been skewed to this lower amount. The 5-year average discount is only 8.26%.
Though admittedly, the fund does frequently trade at around the 10% discount level looking at the chart. But strangely enough, the fund has even reached premium levels on several occasions since its launch.
(Source - CEFConnect)
All this to highlight that at the current discount, the downside from a further widening of the discount seems limited.
Annualized returns over the longer-term have been rather reasonable. However, looking over shorter periods we do see the fund has struggled. I believe this is mostly associated with 2020 being such a difficult year for REITs. For those of you that remember, 2018 wasn't a particularly strong year either. Which 2018 was "harder" on JDD than 2020 even was.
Thus, if you are optimistic about a continuing recovery of the economy, as I am, then this discount could be combined with the current undervalued status of REITs themselves. The fund even has senior loan exposure - so if one anticipates rates heading higher - then JDD will benefit from that too in the form of greater earnings for the fund.
(Source - Fund Fact Sheet)
The annualized returns above are for the period ending December 31st, 2020.
Distribution - Attractive Rate, But Coverage Should Be Watched
The fund currently pays out a distribution yield of 8.67%, on a NAV basis this works out to 7.39%. This is quite attractive for most income investors. Though they have reduced several times now starting in 2018. Under current distribution coverage figures, it could remain under pressure too.
(Source - CEFConnect)
One of the biggest hits to net investment income [NII] would be the reduction in leverage. That is helped offset a bit by the reduced expenses it then has.
A second factor to hit NII would be their senior loan sleeve. As interest rates were targeted to 0% by the Fed, this portion of their portfolio took a hit. Again, helped offset by lowered interest expenses on their remaining leverage. However, not enough to offset the reduction in interest received from the portfolio.
The report we are looking at is the Semi-Annual report that ended June 30th, 2020. We know they have continued to add back leverage as the recovery takes hold. This will likely increase NII to some extent again when they next report. It would still be anticipated to be lower year-over-year. For this reason, I continue to believe that there will be pressure on coverage.
(Source - Semi-Annual Report)
NII coverage at that time worked out to ~40%. This can be an issue when 50% of your portfolio is in bond investments as the bulk of earnings will be in the form of interest payments - and not capital appreciation.
That being said, that report is also highlighting distributions paid before the cut took place in July's distribution. Therefore, based on the current distribution and last reported shares outstanding; they would require approximately $15.473 million to fund the distribution. That would be a reduction from the annualized figure of $16.322 million.
This all still just works out to be short on coverage. So while I'm optimistic about the fund's underlying holdings and find it to be a rather attractive investment, this is a sore point for the fund. Primarily because they have already cut their quarterly distribution several times and it doesn't seem to be enough to get earnings to align with the payout.
Holdings - A Little Of This, A Little Of That, But Heaviest In REITs
I admit I love REITs (almost as much as I love utilities.) They are just a great investment for most income investors. They allow exposure to various sectors and can sometimes be classified as an asset class on their own.
For JDD, we can start with a higher-level look at the fund. It is composed of common stocks and bonds, as we've been mentioning. However, common stocks represent the largest allocation because the debt side of the portfolio is broken up amongst several other subcategories.
(Source - Fund Website)
I believe the senior loan exposure is quite intriguing at this point. Now that rates are at such lows - and considering that the U.S. is reluctant to go lower than 0% - I believe that the next logical place for rates to go would be up. Therefore, senior loan funds would soon feel the benefit as they are floating-rate investments. Meaning that their interest payments go up and down based typically on LIBOR + a spread. That being said, there is a "floor" that they would have to get through first.
When we start looking at the top industries that are classified. That is where we see REITs take the dominant position. This is followed by sovereign debt.
(Source - Fund Website)
I believe this also furthers the unique character qualities of JDD - a REIT fund mixed with senior loans and sovereign debt. There just isn't another fund that I can think of off the top of my head with this approach.
These debts come from a plethora of countries around the world. Some of the largest allocations being to; Mexico (2.3%), Panama (2%), Russia (1.7%), Brazil (1.6%), Indonesia (1.6%) and Colombia (1.2%).
These are allocations based on managed assets, which factored in leverage which put total investments at 146% - and not 100%. I mention this because we don't see some of these names in the top country allocation in the paragraph below on country exposure. There, they are looking at the total portfolio at 100% of investments - though due to rounding could be a bit above or below.
As for the country exposure, the U.S. is the largest allocation at 55.8% of the portfolio. This is followed by Germany and the U.K. at 3.4% and 3.3%, respectively. We then move over to the other side of the world with Japan and China exposure at 2.4% and 1.8%, respectively. Outside of the U.S., there really isn't a strong exposure to one geographic region over another.
The credit quality of the bond portion of their portfolio is mostly high yield type investments. This can increase risks and means the fund can attribute to the fund being sensitive to economic situations. This is exactly what we have seen in combination with their tilt towards REITs too.
(Source - Fund Website)
Senior loans are primarily issued by junk-rated credit companies. Meaning that a higher allocation to lower credit quality debt isn't unexpected.
The effective maturity of the fund's fixed-income positions is 9.58 years. Though their effective duration is only 1.69 years, which seems rather low relative to the maturity. I believe senior loans are at work here too. Since senior loans don't have duration risk - due to benefiting from interest rate increases after passing through the floor.
Additionally, high yield bonds also keep duration lower as they are more impacted by economic situations and have shorter maturities in general.
(Source - Fund Website)
Finally, we can take a look at the top holdings in the fund. They are predominantly REIT common stock investments. Since the portfolio also has 492 positions the last time they reported on January 31st, 2021 - it means that they don't make up a particularly aggressive portion of the portfolio. The top ten comes to 12.3% of the portfolio.
(Source - Fund Website)
Several of the top holdings I see as quite attractive to hold, even during economically challenging times. That being said, it didn't translate into being able to buck the overall trend of the rest of the portfolio.
Equinox (EQIX), the top holding, is "the world's digital infrastructure company, enabling digital leaders to harness a trusted platform to bring together and interconnect the foundational infrastructure that powers their success." They are classified as a specialized REIT, and all this fancy jargon to say they own facilities for internet and data centers.
EQIX last reported some strong earnings on February 10th. For 2020 they increased revenue 8% year-over-year. That is huge considering the economic environment. However, it is this type of REIT that gets even more demand as things move digital. They boasted the "72nd consecutive quarter of revenue growth."
For a REIT, we would also want to look at funds from operations [FFO] or adjusted funds from operations [AFFO]. This is because this is what REITs are earning to pay shareholders. Here too EQIX put up some attractive growth of "9% increase over the previous year or 12% on a normalized and constant currency basis." Their guidance for 2021 also is anticipating the same 8-10% range of growth going forward as well.
Prologis Inc. (PLD) is another REIT that should continue to benefit from the way the world works now. Get ready for the embellishing; they are a "global leader in logistics real estate with a focus on high-barrier, high-growth markets." Classified as an industrial REIT, they own warehouses for both "business-to-business and retail/online fulfillment."
More online shopping means more opportunity for this REIT to put up more facilities. They also had some great earnings when they reported on January 26th, 2021. Core FFO came to $3.80 for the full year 2020, compared to $3.31 for 2019. Revenue year-over-year popped over 33.2%.
I believe JDD is more economically sensitive than other options out there. Therefore, I believe it is higher up on the risk spectrum and should be approached as such. The leverage will also increase these risks, as well as its relatively smaller size. The distribution coverage remains weak, though could improve with a continuing recovery.
That being said, overall JDD seems like an interesting fund for those willing to take on some additional risks at this time. It certainly is rather unique in their approach to investing - allowing quite the amount of flexibility - yet remaining well within an income-focused investment.
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