Last time we covered Aberdeen Global Premier Properties Fund (NYSE:AWP), we gave the firm a firm no and stamped a sell rating on it. While believed back then that the distribution was safe, we did not see good prospects for owners of this fund. Specifically we said,
We rate the fund a sell and think there are better direct choices for real estate exposure and yield.
The CEF took the cue and tanked hard.
Has the thesis played out? We look at that next.
In the case of AWP we had seen the convergence of multiple negative factors that led us to do a downgrade. The first was the holding choices of extremely costly REITs, like Prologis (PLD) and AvalonBay Communities (AVB). We felt these REITs would have an above average risk of multiple compression stemming from cap rate expansion.
We don’t think this risk has fully played out. Our forward return indicators for the REIT indices is now pointing to still further stress and this comes from the explosion in corporate bond yields. As income securities, REITs compete with high quality bonds and when yields on one rises, the other follows. We expanded on this model in our latest marketplace post this week.
Now, AWP’s distribution yield is far higher.
That might lead some to believe that AWP has already discounted the risks. That is nowhere close to the truth. Most of the distribution yield is via a return of capital. The underlying securities don’t generate anywhere close to that. Most of its top 10 holdings like PLD, AVB, Welltower Inc. (WELL) and Equity Residential (EQR) average well under 3%.
If you extrapolate this to the entire set we get about a 3.25%-3.50% overall yield. So AWP’s holdings remain at risk of a larger drawdown here and we think we are not completely done in this regard.
The second factor was the fund was trading a small discount to its NAV. We believed that this was a function of the market hunger for yield and was going to be “fixed” the hard way. This has also partially fixed itself and the discount has expanded by about 4%.
4% may not seem like a lot but a 4% drag over 5 weeks is a lot of drag in a selloff.
While REITs are touted as inflation hedges, and we admit they can work for that purpose, valuation plays an important role in that. High multiple REITs will tend to suffer initially as interest rates rise and cap rates blow out. The most sensitive will be the ones with extremely high multiples and bond-like characteristics. Safehold Inc. (SAFE) is a great example of a poor inflation protection holding that is most sensitive to rising bond yields.
As yields rise further, expect the pressure to move down the chain. Beyond the cap rate changes, REITs will find it harder to find growth when their cost of their equity moves below their NAV. In the longer run, replacement cost increases and rent and expense flow through will kick in and help them act as good inflation hedges. We don’t believe this process has been completed and AWP is likely to suffer. AWP’s real underlying holding yield is near 3.25% and those are not securities we want to own here. Even the distribution coverage relies heavily on capital appreciation. If you take the 3.25% yield enhance it by leverage, net out interest expense (which will be rising) and management fees, we get back to a 3.0%-3.50% real yield from the underlying securities. Will AWP get the capital appreciation to fund the 9% yield? Not any time soon according to us. So this is a poor total return fund for us.
That said, AWP is now far better priced to deal with the rate shocks ahead. The widened discount is closer to reflecting the stress. The US dollar has also done a good deal of the possible mauling of AWP’s foreign securities. We are hence upgrading this to a Hold/Neutral. This cancels out the Sell/Short Sell rating earlier. We still are avoiding closed end funds that employ leverage (which is almost all of them), so AWP remains outside our circle of trust for a buy.
Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.