By Courtney Darby
The Delaware Dividend and Income Fund's co-portfolio manager Damon Andres wasn't daunted by April's market volatility for real estate equities. Despite market turbulence, this non-dedicated REIT fund has maintained a significant portion of its allocation to REITs. Andres says that while he forewarned clients about the correction, ultimately the downside he saw was limited.
"We were out telling clients before first quarter's end to expect a correction in the market. With that being said, what we saw in April will undoubtedly create a lot of volatility in the market and there will be redemptions that will weigh on the market," Andres says.
"There is clearly nothing negative from a fundamental standpoint—if anything, fundamentals are getting better. Stocks march to their own beat sometimes. The good thing about real estate is that assuming fundamentals are stable, there is a valuation floor where there becomes an outright arbitrage of publicly traded real estate. The downside is limited." Andres believes REITs will still post mid-to-high single-digit returns for 2004. Showing continued confidence in REITs as an asset class, the fund currently has a 20 percent REIT allocation. According to Andres, the closed-end fund attempts to be an all-weather investment vehicle that has a significant piece of total return coming from income. The fund's mantra is to never put all its eggs in one basket, he says.
"Ultimately we came up with four asset classes that really compliment each other well in terms of low-correlation and ability to play multiple sectors of the market," Andres says. "The four classes are convertibles, high yield bonds, value equities (primarily large-cap value) and REITs."
Andres, a University of Richmond graduate with a B.S. in business administration, was first introduced to REITs when he joined Delaware Investments in 1994. For Andres, REITs are valuable as an asset class primarily because of the integral diversification they provide a portfolio.
"Within REITs you can play multiple sectors (such as regional malls, industrial, hotels, office, etc.) and that is what gives another aspect of diversification to this fund," Andres says.
While stable and growing dividends are a key component for Andres' fund, valuation, adjusted funds from operations (AFFO) yield and quality of cash flow are three other core metrics he uses to judge a wise investment.
"While a company may offer a good valuation on AFFO yield, it might be a very questionable/
risky cash flow stream that the REIT is generating. We'll trade up for quality and consistency in cash flow to try to provide a more stable level of income," Andres says. "At the same time, not wanting to buy what I call the ‘darlings of Wall Street,' which are overpriced. We take a bottom-up selection approach, focusing on stocks that are going to provide the stable income cash flow, but offer growth potential as well."
As for particular REIT stocks, Andres is fond of First Potomac Realty Trust (NYSE: FPO) and Home Properties, Inc. (NYSE: HME).
"First Potomac possesses a strong presence in industrial and flex markets and has a strong management team," Andres says. "I like Home Properties because of its focus on redeveloping assets, stable resident base, location in supply constrained markets and attractive valuation."
Within the fund's 20 percent REIT allocation, Andres tries to avoid an overweight of any particular sector.
"Currently, we like office REITs from a valuation perspective," Andres says. "We also like the retail sector and hotels, although a lot of them aren't paying dividends, so it is just a couple select hotels."
