A former real-estate-focused fund morphed into a globally invested hybrid fund over the course of a few years.
This once erratically performing real estate fund got an extreme makeover: a new strategy, name, advisor, and two new management teams. Prior to 2009, the fund invested mostly in real estate securities and was called Dividend Capital Reality Income Allocation Fund. The fund struggled in 2007 and 2008 (losing 41% and 66% of its net asset value, respectively), and the board of directors proposed some drastic changes to shareholders. The fund would no longer focus solely on real estate securities nor would it be required to hold a minimum allocation to foreign securities. It would change its monthly level-rate distribution policy and begin to pay a quarterly distribution, and it would change its name to DCA Total Return Fund. Finally, Calamos Advisors was recommended to serve as the fund's subadvisor. Shareholders approved the changes but a modified version of the advisory agreement. The fund's previous subadvisor, Dividend Capital, still managed its real estate and debt securities while Calamos took over the common equity allocation.
Soon after these changes took hold, shareholders approved even more changes. The fund removed all of its real estate restrictions and merged with DCW Total Return Fund DCW. Finally, in late 2011, the board suggested and shareholders approved Virtus Investment Advisors as the fund's new advisor and a name change to Virtus Total Return (the ticker remained DCA throughout). The transition was complete in December 2011.
Although it is difficult to pass firm judgment on the fund as these changes have been dramatic and still recent, investors should be pleased with the results thus far.
Strategy: What's the Story?
DCA is now a globally invested hybrid fund that holds a portfolio of both equity and fixed-income securities. The fund's equity portion is focused on infrastructure, energy, communications, utility, and transportation industries and is run by Duff & Phelps Investment Management, a subadvisor that runs numerous CEFs following a similar strategy. Managers believe that the fundamentals of many infrastructure firms remain sound despite a weak economic recovery. Because many of the firms have relatively inelastic demand, they have generally performed well over the past few years. Demand is inelastic because of the essential nature of the firms' output like communication lines, oil, gas, and electricity. Despite rising prices, consumers still need to heat their homes, fill their cars with gas, and make phone calls, limiting a decrease in demand during recessionary periods. This provides a cushion for investors. What's more, many of these firms pay dividends, which also soften the blow in recessionary and slowly recovering environments.
The fixed-income portion is run by Newfleet Asset Management. The team employs an active sector rotation management style, avoids interest-rate bets, and attempts to remain duration-neutral against the fund's benchmark. The fund holds a variety of fixed-income securities including emerging markets, high yield, bank loans, and nonagency commercial mortgage-backed securities. Analysts perform detailed credit analysis on each security. The fund benefited from many of its high-yield holdings (both emerging market and domestic) last year as default rates remain low, fundamentals remain strong, and spreads remain favorable.
Overall, the managers (both equity and fixed income) view European firms with caution, preferring to invest more heavily in North America. This is evident in its holdings as of Dec. 21, 2011, which leaned toward the United States and Canada (70%). About a fourth of holdings were invested in Europe, and the remaining holdings were invested in Asia and Australia. The fund had 45% of assets invested in common stock, 25% in corporate bonds, and a small portion in MBS, government securities, loans, municipal bonds, and asset-backed bonds. Equity holdings were heavy in communications, energy, utilities, and industrials. The fund's largest holding was Dreyfus Cash Management DICXX, a mutual fund invested in cash and cashlike securities. This accounted for nearly 12% of the fund's portfolio.
Performance: Is the Fund Successful?
Against the Morningstar U.S. Global Hybrid CEF peer group, the fund's performance has been good: It beat the peer group's average performance in both 2010 and 2011 and is beating the group over the two-year annualized period (19% versus 8%). The new team has only been on board for a few months, but the fund has performed in line with peers so far this year. Duff and Phelps has a strong long-term track record with a number of its CEFs, including
Since the fund decided to make quarterly distribution payments and to lower its distribution by more than half, it has only made distributions from income earned. Its 7.5% distribution rate at net asset value is on par with the peer group. Previously, the fund's undistributed net investment income, or UNII, balance was heavily negative. It is now $0.08 per share.
Finally, patient investors who held on through all the changes have been rewarded as the fund's discount has narrowed significantly to 9.5% from nearly 13% a year ago, 18% two years ago, and 14% three years ago. The current discount is slightly wider than the peer group's average discount of 7.5%.
People: Who's Managing the Fund?
The fund's parent is Virtus Investment Partners, an enterprise of boutique investment managers. Duff & Phelps Investment Management Co., one of the fund's subadvisors, has been in the investment advisory business for more than 70 years. The firm manages five CEFs, including this fund: DNP, Duff & Phelps Global Utility Income Fund DPG, Duff & Phelps Utility and Corporate Bond Trust DUC, and DTF Tax-Free Income DTF. These funds (aside from DPG, which had its IPO in 2011) have been in existence for more than a decade each, and performance has been good. Randle Smith and Connie Luecke are the portfolio managers from Duff & Phelps. Smith and Luecke have been with the firm since 1998 and also serve as comanagers and analysts for other Duff & Phelps CEFs. The two run a total of $3.1 billion in assets.
Newfleet Asset Management, the fund's fixed-income subadvisor, runs numerous fixed-income funds for Virtus, many of which have performed well. Newfleet has $8.8 billion in assets under management. David Albrycht is CIO of multisector fixed-income strategies and has been managing this fund since the takeover in late 2011. He also manages or comanages a number of mutual funds: Virtus Multi-Sector Fixed Income Fund NAMFX, Virtus Multi-Sector Short Term Bond Fund NARAX, Virtus High Yield Fund PHCHX, Virtus Senior Floating Rate Fund PSFRX, and Virtus Tactical Allocation Fund NAINX, and also a portion of the Virtus Multi-Sector Fixed Income series of funds and the Virtus Strategic Allocation series of funds.
Risks & Concerns
The biggest concern for investors is the uncertainty of this team's performance. Although both have strong histories separately, they have only a short track record together. The portfolio's focus on asset-heavy firms, many of which pay regular and steady dividends, inherently mitigates some risk in the portfolio. These firms tend to be more defensive than cyclical as demand remains relatively strong during recessionary times. Its fixed-income holdings are well-diversified across asset classes and individual securities and provide additional income for distribution. The fund utilizes only a small amount of leverage, also lowering volatility against its more heavily leveraged peers. This fund's strategy should provide investors with a steady stream of income with low risk. Only time will tell if the new managers can produce strong and consistent results, but the track records at other CEFs offer a promising sign.