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)
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.
10 Highest Yields
But where the coverage is above 99% and the shares trade at a discount. Sorted by descending yield.
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.
Total Net Assets: $339M
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.
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
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.
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.