When it comes to tapping into attractive market sectors, I like to leverage the skills of others, those who have more experience, knowledge, or time to manage portions of my portfolio. I do this by using diversified funds. The fund wrapper, whether it's an ETF (Exchange-Traded Fund) or CEF (Closed-End Fund), allows you to buy into a fund that is managed by someone with superior skills and experience.
A leveraged and actively managed portfolio of preferred securities presents an easier way to fortify your portfolio defenses and position yourself for the upside with more rate cuts. Even if we don’t see as many rate cuts as the market expects, the CEFs we discuss today will provide great income nonetheless. Let’s dive in!
Pick 1: RNP – Yield 7.2%
U.S. REITs raised $17.9 billion from debt and secondary equity offerings of common and preferred shares in Q3 2024. This marks the largest capital raise since 2021. The average yield to maturity for REIT unsecured debt offerings was 5.2%, with an average spread to similarly dated treasuries of 1.4%. This indicates that REITs, with their high-quality balance sheets and robust operating fundamentals, maintain low-cost access to the debt markets despite elevated rates.
This positions them well for asset acquisitions and M&A pursuits when market valuations are still cheap, setting the stage for long-term growth in operating income and shareholder dividends. Along with preferreds, REITs are also well-positioned for significant upside with rate cuts.
Cohen & Steers REIT and Preferred and Income Fund (RNP) allows us to invest in both these areas through a single monthly-paying CEF. RNP is deeply diversified across 310 holdings, with 49% representing equity REITs and 51% coming from preferred equity from non-REIT companies, majorly financial services.
Notably, the REIT portion of RNP’s portfolio, despite representing 49% of total assets, comes from just 31 REITs, indicating a concentrated position in some of the highest-quality REITs in the public markets. Its top 10 REIT holdings comprise ~32% of the invested assets.
RNP Fact Card
RNP’s fixed income portion is highly diversified across numerous issuers, coupons, call dates, exchange-traded, and over-the-counter securities.
RNP pays monthly distributions, which it has maintained and grown since its inception in 2003. Thanks to the shift in interest rate policy, the CEF has been benefiting from improving REIT valuations and the shrinking gap between the market price and the par value of its preferred.
Pick 2: DFP – Yield 6.8%
Trading at a ~9% discount to NAV, Flaherty & Crumrine Dynamic Preferred and Income Fund (DFP) provides a bargain opportunity, allowing you to buy an already undervalued asset class at a further discount. This CEF (Closed-End Fund) is composed of preferred securities issued by regulated institutions, namely banks, insurance firms, utilities, financial services, and energy companies. Together, these sectors comprise ~95% of the fund’s AUM (Assets Under Management), and ~68% of its holdings generate Qualified Dividends. Over 50% of the fund’s holdings carry investment-grade ratings, indicating the overall creditworthiness of its assets and their suitability for income investors.
You may wonder why we are pounding the table for a CEF yielding 6.8%. The reason is the visible case for distribution raises with rate cuts. DFP’s distributions are variable; the fund distributes what it earns as Net Investment Income. Moreover, the CEF operates with a ~38% leverage, which carries an annual interest rate of SOFR + 0.90%. For 1H 2024 (as of May 31, 2024), the daily weighted average annualized interest rate on DFP’s leverage was 6.218%, and due to its floating nature, the fund has experienced rising interest expenses since mid-2022.
Author's Calculations
As seen from the chart above, through the Fed’s quantitative tightening, DFP has consistently generated a growing top line through its prudent portfolio management. While other fund expenses remained relatively flat, the only parameter that shrunk the bottom line was interest expenses, leading to shrinking distributions along the way. This has already begun reversing, and we expect a growing NII with every interest rate cut.
DFP presents a suitable investment for improved stability and low correlation with equity valuations and market movements. At the same time, due to its composition and discounted valuation, the CEF presents a case for growing distributions (with the possibility of special distributions fueled by its realized capital gains, as we saw in FY 2023).
Conclusion
With RNP and DFP, we're able to leverage the skills of Cohen & Steers and Flaherty & Crumrine, two highly experienced fixed income managers, to benefit our income portfolio by providing us with great income and the expectation of capital gains as we go down the road of rate cuts. This allows us to enjoy the income today and expect that that income will continue to pour in looking forward because of the skills and expertise of the portfolio managers. I enjoyed leveraging the skills of others to my benefit.
You can achieve this by having a financial fortress to rely upon that can be buffeted by the winds of life or the storms that may arise and provide us the protection and security you need. This forms the basis of our investing strategy at High Dividend Opportunities, and we enforce this through our deeply diversified model portfolio of over 45 income-focused picks. Holdings like RNP and DFP as part of your portfolio will make that fortress stronger. That's the beauty of my Income Method. That's the beauty of income investing.
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