After Tuesday's column on income investing, an old friend remarked that he really didn't think that Wall Street was all that bad about producing products designed to remove piles of fees and commissions from the pockets of income investors. I ran down the list of some of the garbage I have seen sold over the years and the outrageous commissions earned by selling them. Those wonderful real estate limited partnerships that were popular in the 1980s paid 8% to the broker and as much as 18% of the proceeds disappeared off the top. The same held true for oil and gas partnerships. The last unlisted real estate investment trust I looked at had a sales commission of 6%. Closed-end funds usually have a commission of about 5%. Annuities can pay brokers as much as 8% and often have deferred sales charges that run for a decade.
I can go on and on but the truth is that Wall Street has long known that income-seeking investors are often the least sophisticated and can be sold a story. They are also unlikely to actually read, much less understand, the offering documents.
Ironically, the aftermarket of one of the most heavily sold fee generators creates a solid opportunity for investors. Closed-end fund initial public offerings are horrible for investors. As much as 7% of the proceeds come off the top of these funds in one fee or another. Once they are listed, they often fall into oblivion and can trade at a discount to net asset value (NAV). This has made a ton of money for people like Phillip Goldstein of Bulldog Investors, as he buys the discounted merchandise and pressures management to eliminate the discount. Since most of these funds pay generous dividends, investors can follow his buying activity and collect dividends while he works to unlock the discount and provide you with capital gains on top of the high yields.
Diversified Real Asset Income Fund (DRA) is a closed-end fund managed by Nuveen Investments that currently trades at just 90% of NAV. This fund never had an IPO but was related by merging four funds that previously invested in bank loans. The fund has been in a state of transition as they look to opportunistically sell off the loan portfolio and reinvest in companies with exposure to real assets such as real estate and infrastructure projects.
Bulldog Investors has pressured the company for a long time and last year management agreed to conduct three tenders for 99% of NAV if the fund traded at a discount of 90% or more during the measuring period. The final measuring period has been announced so if the fund averages a discount of 10% or more from July 10, 2015, and ends on Oct. 7, 2015, the fund will conduct a tender at 99% of NAV. In exchange for this agreement, Bulldog and fellow investor Sit Investment Associates agreed to refrain from additional activist activity until September 2016.
Now the portfolio is heavily into common and preferred stock as well as debt of commercial real estate companies. They also have exposure to energy-related debt securities purchased after oil prices fell sharply. The fund is very well positioned and would be appealing even without the activist presence in its shares. The yield is 9.5% and dividends are paid monthly, so you are collecting a nice cash flow until the next tender offer later this year. If the average discount is less than 10%, there of course will not be a tender, but your shares will most likely have gone higher to reduce the discount, so it will be tough to complain about that. If the discount still exists next year, it is highly likely that Bulldog comes back with another activist campaign to unlock the value DRA shares.
Income is hard to find in a world of zero interest rate policy (ZIRP), and it is not going to get better any time soon. While Wall Street is working hard to find new stories to sell you to meet the needs of income investors, odds are the results from this new crop of sexy-sounding products will have the same poor results every other "can't miss" income-producing product has delivered over the year. Income investors need to think differently, and mimicking the closed-end-fund activists can help produce the yield you need with a high possibility of capital gains as a bonus.