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This 11.5% Yielder Should Be Sold Immediately + 20% Off Annual Sale

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Recently a well-known financial publication wrote an article telling readers to "grab this 12.5% dividend from an ignored fund."  The article was all fluff without a bit of fundamental research of the fund.  The closed-end fund in question is the Brookfield Real Assets Income Fund (RA).  

This is a fund that is marketed as a "real asset" which is a take on infrastructure investing.  Real assets are primarily natural resources, real estate, infrastructure and similar assets.  

From the article:

Most folks would simply buy in through RWR, but we’re CEF investors! We don’t settle for 3.7% yields like the ETF pays when it’s so easy to go one step further and grab ourselves in a huge 12.5% payout.

This is one of the larger mistakes CEF investors make.  They equate yield to value, and all else being equal a higher yield equates to a better fund value.  

This is patently false.  A CEF can make a distribution as high or as low as they want.  In fact, in a quirk of our 1940 Investment Company Act, it is easier to make a very high distribution rate than a very low one.  This is because the act forces the fund to pay out at least 98% of ordinary income or they get assessed a 4% excise tax on the undistributed income. 

But the other way, with a higher yield, there is no penalty for a fund paying out distributions far above what the fund actually earns.  A fund can set a distribution at whatever level they wish.  Some funds that do this include RiverNorth Opprutnities (RIV) or Cornerstone Strategic Value (CLM)

These funds have yields in the teens but of course they don't actually earn anywhere near that level in net investment income.  Instead, they are simply paying you back your own principal, called a return of capital ("roc"). 

RA is in this category.  They have a yield of 11.5% (down from 12.5% thanks to the recent run) but that is not earned.  As of their last filing which goes through 6/20/2020 [a new semi-annual report will be out in about 10 days] the fund was earning 33.5% of the distribution.  The rest was from gains or roc.  

That high yield entices some investors in.  11.5% yield in a world where interest rates are 1.5% sounds great!

And just because the fund is paying roc and is over-distributing isn't bad in of itself.  But roc and good roc are a bit more gray than black and white.  RA has a lot of equity exposure (approx 34%) which obviously do not produce a lot of income.  So you are banking on those stock producing gains to "fund" distributions.  

More to the point, this fund is now trading at a premium to NAV of over 4%.  There is no reason this fund should be trading that rich.  The long-term performance is lackluster.  It's trading at a premium because investors are being duped by a yield that is not earned.  This is when a fund that over-distributes is not a good investment.  

I would not own RA here.  The fund is trading at a 4% premium which is the first time the fund has ever traded at a premium.  The z-score, which is a measure of the number of standard deviations above the average discount over a specific time period, is +4.2.  Anything above +2 is richly priced and really should have some sort of catalyst to support that valuation.  

At +4.2 the fund is very overpriced.  So much so that I would actually consider selling it short and I almost never sell a fund short unless I have 110% conviction in my thesis. 

If you own RA, I would be selling ASAP.  You could rotate into another "real asset" fund.  We like Nuveen Real Assets Income (JRI).  The fund has performed very well lately.  The discount is relatively tight but at least it's still a discount!  The yield is just under 8% and the NAV is rising nicely.  

Data by YCharts

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