Power Rankings

YH Power Rankings Report | March 2019

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For those that are familiar with the ESPN NFL Power Rankings, which rank the teams from 1-32 based on the opinions of several staff members, than this analysis will be familiar to you. Here we are ranking the entire CEF universe (~580 funds) using several factors and then applying a scoring methodology to it in order to rank the funds.

We will be doing this each month in order provide a starting point for analysis and due diligence.

What are we looking for here and how are we ranking?

Coverage: > 99%
UNII: > 0 
Yield: Higher is better
Discount: Lower is better
Z-Score: < -1 (lower is cheaper)

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In aggregate, we had only 6 funds meet the screen, down from 15 last month and over 40 the month before. We again relaxed the UNII threshold (eliminating it) and the z-score screen to 'lower is better.'  

That widened the field to some 105 funds.

10 Largest Discounts

But where the coverage is above 99% and the shares trade at a discount. Sorted by discount ascending.

Looking Deeper Into Pioneer High Income Advantage (MAV)

This is the sister fund of one we recently sold, Pioneer High Income (MHI).  The funds are very similar but with one key distinction:  the fiscal year end's are one month off.  In other words, the fiscal year end for MAV is March 31 while the year end for MHI is April 30.  

With very similar portfolios, what MAV reports the other (MHI) is likely to report one month later.  In January, MAV announced a sizable distribution cut going from $0.0525 to $0.0425, -19%.  Meanwhile, still MHI has not cut.  

Pioneer (Amundi) is a semi-annual reporter and the last data we have is from the end of September/end of October.  For MHI, the coverage rate is 91% with UNII of 12.7 cents.  For MAV, coverage is now 106.6% (based on the new distribution but earnings from Sept) with UNII around 8 cents.  

If we use MAV as a template for MHI, it is clearly time to get out of the latter as the lower coverage ratio continues to drain UNII.  A cut for MHI is likely imminent.  

So is MAV a good place for that income now that they cut and being one of the few values left in the muni CEF space?  Well, we are in the process of researching for our muni update but looking at the characteristics of the fund itself, it trades at a nice discount thanks to the distribution cut.  What we typically find is that the discount widens for about 2-4 months following a large cut before it bottoms out.  

The yield for MAV is much lower following the cut at 4.82%, vs. 5.32% for MHI.  Of course, MHI wasn't earning that distribution back in September and is unlikely to be earning it six months later either.  We will receive new earnings and UNII data in late May for MAV and late June for MHI.

MAV may look cheap but when we run it through our model, the discount is actually warranted based on its "type" and the yield it produces.  The model essentially looks at all national muni funds and compares them based on discount, yield, whether they are a term trust, perpetual true, or target term, and lastly, among other factors.  

The warranted discount for the fund based on the regression is approximately -7.3%.   Right now, it trades around -8.2% so a bit less than 1% until it gets to our target discount.  Note, that this is about a point higher than the 52-week average of 6.25%.  

While there is a chance that the discount tightens a bit just because of the current state of the muni CEF market.  Most muni CEFs trade tighter than their 1-year average.  We think there's a less than 50-50 shot it gets closer to and trade just above the 52 week average.  This would be at the $10.73-$10.75 level.

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MAV is the second best fund YTD on a NAV basis at +2.51% for the high yield muni sector.  The fund that we largely swapped to was Nuveen High Income (NMZ), which was the only fund that bested it at +2.87.

Some data on the fund MAV:

We think there's significant risk given the call schedules of both funds.  Below is MAVs call schedule with 58% becoming call eligible in the next five years, opening them up to the possibility of being replaced by lower yielding issues.  I say 'possibility' because some issues that are call-eligible are not being called for various reasons, including because current yields are not any lower than the current issue.  This is the first time in quite a while that this has been the case.  

Pioneer doesn't break it down by year so all 58% of those calls could be in year 4 or 5 and not effect the portfolio for a number of years- we just don't know.  And uncertainty requires a discount to the average spread the fund would typically trade from NAV.

Concluding Thoughts:

We do not think MAV is a "deep value" muni opportunity but trading near its warranted discount to NAV.  Of course, we could see an influx of buying providing a small bump to the price closing the discount a bit temporarily.  Still, we would avoid both. Our thesis for owning MHI despite that call schedule was based on the fact that they had raised their distributions.  And near-term, the fund that raises the distribution likely has the safest distribution.  Fast-forward a year and things can change.  With MAV cutting, MHI is clearly on the chopping block.  Buyers and holders beware!

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YH Power Rankings Report | February 2019

For those that are familiar with the ESPN NFL Power Rankings, which rank the teams from 1-32 based on the opinions of several staff members, than this analysis will be familiar to you. Here we are ranking the entire CEF universe (~580 funds) using several factors and then applying a scoring methodology to it in order to rank the funds.

We will be doing this each month in order provide a starting point for analysis and due diligence.

What are we looking for here and how are we ranking?

Coverage: > 99%, 
UNII: > 0 Yield: Higher is better, 
Discount: Lower is better, 
Z-Score: < -1 (lower is cheaper)

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In aggregate, we had only 15 funds meet the screen.  Thus, we relaxed the UNII threshold (eliminating it) and the z-score screen to -0.5 to include more funds in our results.

That widened the field to some 36 funds.

10 Largest Discounts

But where the coverage is above 99% and the shares trade at a discount. Sorted by discount ascending.

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10 Highest Yields

But where the coverage is above 99% and the shares trade at a discount. Sorted by descending yield.

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10 Lowest Z-Scores

But where the coverage is above 99% and the shares trade at a discount. Sorted by ascending z-score.

10 Highest Overall Score

But where the coverage is above 99% and the shares trade at a discount. Sorted by descending overall score.  The scoring takes into account the all four factors that we look at:  discount, earnings coverage, total yield, and one-year z-score.  By combining the four factors we are able to produce a total score.  

Looking Deeper Into RMR Real Estate Income (NYSEMKT:RIF)

RMR Real Estate Income (RIF) is a relatively illiquid fund (35K daily shares traded) that invests primarily in real estate companies.  These are so-called eREITs that dominate the REIT sector.  

The investment policy:

Generally, in normal market conditions, we expect that: (I) at least 90% of the Fund’s managed assets will be invested in income producing securities issued by real estate companies, including common shares, preferred shares and debt; and (II) at least 75% of the Fund’s managed assets will be invested in securities issued by REITs, and (III) no more than 10% of the Fund’s managed assets will be invested in securities denominated in currencies other than the U.S. dollar or traded on a non-U.S. stock exchange.

The portfolio has 80% in stocks and 20% preferreds of REITs.  

The top ten holdings are skewed towards the larger REITs in the sector with a large and diverse holdings base.  

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Characteristics:

  • Total Net Assets:  $339M

  • Leverage:  31.2%

  • Expense Ratio: 2.57% (including interest expense)

  • Daily Trading Volume:  35,000

  • Current Discount to NAV: 22.6%

  • 52-Avg Discount to NAV:  19.75%

  • Distribution Amount:  $0.33 paid quarterly

  • Distribution Yield:  7.42%

As we noted the fund invests in securities that pay a high level of current income on common stock.  The second primary objective is to earn capital appreciation.  

In September of 2017, the fund completed their rights offering issuing another 2.5 million shares at an average price of $17.75 raising another $45 million in common equity capital.  At the same time, they raised their borrowing capacity to $88 million from $28 million through their revolving credit facility at BNP Paribas.  The interest rate on that leverage is libor plus 95 bps.  

About RMR:

RMR Advisors LLC, the adviser to RMR Real Estate Income Fund (RIF), was founded in 2002 and is focused on investing in real estate securities, including real estate investment trusts (REITs) and other dividend paying securities. As of September 30, 2018, RMR Advisors LLC had approximately $336 million of assets under management. RMR Advisors is a wholly owned subsidiary of The RMR Group LLC.

About The RMR Group LLC The RMR Group Inc. (Nasdaq: RMR) is a holding company and substantially all of its business is conducted by its majority-owned subsidiary, The RMR Group LLC. The RMR Group LLC is an alternative asset management company that was founded in 1986 to invest in real estate and manage real estate related businesses. RMR’s business primarily consists of providing management services to:

  • Five publicly traded eREITs

  • One publicly traded mREIT

  • Three real estate operating companies

  • One closed-end fund focused on investing in real estate securities

  • Other private funds and accounts that invest in real estate securities

Commentary

When analyzing a fund that invests in equities, one of the first things one should do it compare the total return NAV performance against key benchmarks.  This fund incepted back in late 2003 and has been around for more than 15 years.   Below shows that cumulative performance.  

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Remember, RIF is a levered CEF, meaning that they are allowed to 'amplify' their returns.  But you can see a simple Vanguard passive ETF, the (VNQ) did far better without the leverage.  This tells me that either the addition of leverage on an already volatile asset class isn't helpful or the management team at RMR isn't strong at selecting securities (the active management). 

Fees are another consideration.  A pure equity CEF that charges 1% in management fees with no leverage, should trade at a sizeable discount.  While this exercise is not exact, think of it this way.  If you can get plain vanilla beta exposure through VNQ for 12 bps, you save nearly 1% per year.  If total returns are expected to be around 6% per year, then you are giving up 16.6% of the return.  All else equal, a $10 NAV fund with a $0.50 annual payout (5%) then should trade around $8.33 for a 16.6% discount in order to generate a distribution yield of 6%.  That is a warranted discount and one investors should not expect to close.

We have mentioned this several times about some big name CEFs including the Boulder Growth and Income (BIF) which trades around a 16% discount.  The fund owns some plain vanilla large-cap equity names including Berkshire Hathaway, JP Morgan, Cisco Systems, Yum Brands, Caterpillar, and Wells Fargo, amounting to over 58% of the total portfolio.  It would be very easy for an individual investor to replicate that portfolio themselves and avoid the egregious 1.28% management fee.  

Given these aspects, we do not think the fund is investable even at these levels.  Nor do we think BIF is a good investment.  

You may be asking why we analyzed a fund we did not like.  The exercise was on purpose as RIF was the top scoring fund, from a quantitative perspective.  However, when we delve into the fundamentals, the fund is a dog.  This is why investors should focus on both fundamentals and the quantitative aspects.

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