2023-11-16 07:48:08 ET
Summary
- Actively managed closed-end fund with high interest rate correlation.
- Leverage of 34% adds to risk and distribution yield of 9%.
- Combination of REITs and corporate debt securities makes this fund a conservative rate play with 12% capital upside potential.
Summary
The Cohen & Steers REIT and Preferred and Income Fund ( RNP ) has a toxic combination of assets when rates jump and outsized returns when rates fall. This is not an investment for those averse to volatility. This may be a great time to buy RNP at the current juncture in the rate cycle.
This investment is unique in that it is not just a REIT fund or a corporate debt fund, but rather a combination of both - with added leverage. The REIT portion of the investment offers a dividend yield of 5%, while the corporate debt side has a yield of about 7%. The investment has US$40 million in rate swap derivatives and US$450 million in debt with a cost of 2.6% and a maturity of 2.8 years. The use of leverage is what allows for higher distribution rates.
Two Years of Turmoil
Over the last two years, as interest rates increased, the value of bonds and bond proxies such as REITs decreased. At the same time, the fund's leverage increased the risk of rising costs and lowered returns. As a result, the market sold off the underlying assets and the fund's value dropped by 40%.
Despite the turmoil in asset prices, RNPs investments continued to pay out dividends and make interest payments. If someone had the foresight to reinvest during the downward trend, they could be greatly rewarded if and when interest rates decline.
Performance
Since its inception, RNP has shown a consistently strong performance when compared to pure REITs and pure corporate bond funds (adjusted for dividends). It has managed to keep up with S&P 500 ( SPX ) up until a year ago. However, when looking at its performance over a two-year period, it is in line with REITs and Bonds, having dropped about 20% when adjusted for dividends.
RNP Performance with dividends (Created by author with data from Capital IQ) RNP 2 Year Performance with dividends (Created by author with data from Capital IQ)
Portfolio Overview
As an actively managed fund, the portfolio of this fund is subject to change. Currently, the assets under management ((AUM)) are divided between 33 real estate investment trusts (REITs) and a few hundred corporate debt instruments , which have varying yields and maturities but are mostly issued from investment-grade companies. I have listed the REITs along with their consensus price targets for the year-end 2024, which indicates a potential upside of 17%. Additionally, I have included two out of four pages of the corporate debt securities that the fund holds to provide investors with an idea of the diversification and yields. In many ways, this aspect of the fund is similar to a corporate bond fund.
RNP NAV Breakdown (Created by author with data from RNP) RNP REIT Portfolio with Consensus Price Targets (Created by author with data from Capital IQ) RPN Corporate Debt Instruments (Image from RPN)
Leverage Structure and Rate Swaps
As per the latest Factsheet , the debt of the funds was equal to 34% of the managed assets, which is US$442 million. Out of this, 81% is at a fixed rate of 1.8% annually, and the remaining is at a floating rate of 6.2%.
In the last financial statement of the funds (June 2023), it is stated that there is one revolving credit line with BNP Paribas of US$450 million with a rate of 2.8% plus LIBOR (now replaced by SOFR), standing at 5.32%. Therefore, the total debt cost is 8.1%. To reduce this debt cost for the next 2.8 years, the fund is using derivatives, interest rate swaps. However, this comes at a cost, with US$40 million allocated to the swaps, which could have been used to invest in REITs or corporate debt.
RPN Leverage (Image from RPN)
Total Return Potential
Since more than half of the assets of the fund are invested in corporate debt the upside of these instruments is opaque. Nonetheless I can assume that they should perform in line with a corporate bond fund such as iShares iBoxx $ Investment Grade Corporate Bond ETF ( LQD ) which is down 16% since the Fed began its rate hike cycle. I doubt the Fed cuts back to zero so the full retracement may be unlikely, but perhaps back to US$112 is feasible with Fed Funds at 3%. This would provide about an 8% capital gain. The REIT portfolio has more upside according to consensus and could gain 17%. Thus, price or capital upside is about 12% plus the distribution or dividend payout of 9% provides a total return of 21%. This can be augmented if an investor purchases more shares with the monthly payout.
RPN Upside Potential (Created by author with data from Capital IQ)
Conclusion
I rate RNP a buy. The combination of fixed income, REITs, and leverage makes this an ideal fund to “conservatively” invest in a Fed rate decrease scenario with a capital appreciation potential of 12%. Add to this the monthly distribution yield of 9% and one can compound potential recuperation in asset prices.
For further details see:
RNP: Leveraged To Fed Rate Cuts