Sources of Income:
You may be wondering how the fund generates an 8% yield when the bonds it holds pay only a 6% coupon and the stocks it owns generally yield a considerably lower amount (in the general range of 3% – 5%). The main answer is leverage, but the fund also has the ability to generate additional cash for distributions via capital gains and in rare cases a return of capital. However, thus far, the fund has only generated income from the income on its investments as shown in the following table (note: the fund’s inception date is 9/8/2014).
Also important to note, because the fund has been paying out only income, the distribution amount has varied as shown in the following graph.
However, based on the fund’s current holdings, it should have no problem generating a continued high monthly distribution payment for its shareholders. And the distribution payment will continue to vary so long as the fund continues to pay out only income. However it’s important to recognize the fund does have the ability to distribute income from capital gains (and in rare cases a return of capital) if need be.
Contrarian Opportunity:
In addition to the big monthly distribution payments, we also like this fund from a contrarian standpoint. First, the fund’s two largest sector exposures, REITs and infrastructure/utilities (benchmarked by the Real Estate and Utilities ETFs, XLRE and XLU, respectively) have recently underperformed the market (as measured by the S&P 500) as shown in the following chart (bear in mind, these returns are price returns, not total returns – they don’t include the dividends/distributions).
We can argue the reasons why real estate and utilities have underperformed lately (e.g. rising interest rates impact these highly levered sectors more negatively, or bullish market sentiment has made these “safe haven” sectors less attractive), but the important observation is that they have underperformed, and from a contrarian standpoint this may be attractive (e.g. what performed worst last year, often performs better this year, and “mean reversion” is real). Additionally, if the soon-to-be aligned White House and Congress follow through on the heavy infrastructure spending that many people expect, this could be a boon for infrastructure and utilities stocks, and the coming inflation could make real assets (such as real estate) appreciate in value nicely.
Discount to Net Asset Value:
Another contrarian reason we consider this fund attractive now is because it currently trades at a big discount to its net asset value (NAV) as shown in the following chart.
Specifically, because Diversified Real Asset Income Fund of Beneficial Interest (NYSE:DRA) is a closed-end fund, its price can deviate significantly from the aggregate market value of all of its individual holdings (i.e. its NAV). The possibility of trading at a large discount (and sometimes a premium) is simply a characteristic of closed ends funds (largely because CEFs don’t have creation units like ETFs), and in this case we consider it attractive (we’d rather buy the shares at a discount than a premium).
We could argue the reasons why the large discount grew in 2016 (for example, aversion to interest rate sensitive and safe haven sectors like real estate and infrastructure could have increased the selling pressure on this fund, and supply and demand caused the discount to grow), but the point is that the discount has grown and it creates a more attractive buying opportunity, in our view (remembering, of course, there are no guarantees the discount will ever go all the way back to zero, and it could actually get bigger).