As investors of closed-end funds, we frequently come across funds with altered or unconventional strategies that are disregarded by the market and trading at deep discounts. Despite being overlooked by most investors, we typically view these funds as opportunities for future performance based on underlying value.
One fund that falls into such category is The Diversified Real Assets Income Fund. The fund is a result of a merger of American Funds, numerous tender offers, a new strategy and, more recently, a new portfolio manager. The fund is also expected to be part of another upcoming merger. The current fund’s objective is to provide a high level of income and appreciation by investing in a spectrum of debt and equity securities within real estate, utilities and infrastructure. Specifically, DRA targets businesses that produce steady and predictable cash flows across equity, preferreds and high-yield debt. The fund will generally allocate a meaningful component to non-U.S. securities, and may opportunistically sell call options to enhance returns over time. The fund also employs leverage.
While it is difficult to benchmark a position like this, we do believe it fits well into an array of portfolios, either as a dividend-oriented equity, or as an aggressive replacement for a fixed income investment. We believe this lack of distinct segmentation is largely why the fund has traded at an average discount of 12.2% since its inception in September 2014. The fund pays out a dividend based on income and currently yields 7.5%. We believe the dividend will be stable for the foreseeable future, which we believe should ultimately draw buyers.
In our opinion the management team has been effective capital allocators and risk managers. The performance since the inception of the fund is 7.4% annualized, which compares favorably to many of the broader segments it invests in. The current allocation is approximately 40% equities and 33% preferred stock with the balance consisting of bonds, both fixed and floating rate, investment grade and high yield. The fund maintains a low duration of 3.76 years, leverage adjusted, on the fixed income portion, and on the equity side, has avoided many of the U.S. retail real estate that has been problematic. Uniquely, the fund does a have the ability to invest internationally, which we view positively, in this environment.
We believe the current 10.5% discount to net asset value represents an attractive entry point for several reasons. In this low interest rate environment there has been increased demand for closed-end funds with attractive yield levels, especially steady ones. The fund is cheap when compared to the median discount for equity closed-end funds, which is currently 7.3% and fixed income closed-end funds are 4.6%. This summer, DRA is expected to merge with the Nuveen Real Asset Income and Growth Fund, making it a larger, more liquid fund that traditionally trades at tighter levels. We expect the larger size may attract more institutional investors. Lastly, we have confidence in the manager’s ability to add value in their broader universe given the flexible mandate of the fund.Read more posts from Maury on Forbes.com