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Natixis CGM Advisor Targeted Equity Fund: An End Of An Era

Summary Natixis Asset Management, the fund’s distributor, has recently announced the closure of the CGM Advisor Targeted Equity Fund to new investors, and plans to liquidate the fund on 2/17/2016. The fund is managed by CGM’s Kenneth Heebner and has been active since 1968. Fund has significantly underperformed the market over the last 8 to 10 years. One of the oldest mutual funds is about to shut the doors. Natixis has just sent out a letter to financial advisor informing them of the board’s decision to liquidate the CGM Advisor Targeted Equity Fund (MUTF: NEFGX ) (MUTF: NEBGX ) (MUTF: NEGCX ) (MUTF: NEGYX ) on February 17th, 2016. As per the letter… The Board considered a number of factors in making this decision. Natixis Funds are managed solely by firms in which Natixis Global Asset Management has an ownership interest. In early January 2016 Natixis will no longer hold any ownership interest in Capital Growth Management (CGM). The Board determined that, since there is no other manager or fund within the Natixis Funds complex that has a similar investment style, it would not be in the best interest of shareholders to have another portfolio manager assume responsibility for managing the Fund or to merge it into another fund. If you are currently an investor, what are you to do? The Basics Originally launched in 1968, the fund has been managed over the last 39 years by Kenneth Heebner. Fund Basics : Sponsor: Natixis Global Asset Management Managers: Sub-Advised by CGM, Kenneth Heebner AUM: $448.53 Million across share classes Historical Style : Large Blend Investment Objectives: Seeks long-term growth of capital through investment in equity securities of companies whose earnings are expected to grow at a faster rate than that of the overall United States economy. Number of Holdings: 21 Current Yield: 0%, Annual Distributions Inception Date: 11-27-1968 Fees: A Share : 1.15%, I Share: .89% Source: Natixis Global Asset Management The fund’s special sauce is twofold. First, the fund is concentrated and typically holds between 20 and 30 securities. The reasoning for this being, if you hold 100 names or more and many funds do, you might as well own an index fund as you are in a quasi index fund with higher fees. As a concentrated fund, you are able to make specific investment bets. The second part to the special sauce is selecting “aggressive large-cap” holdings with a competitive long-term track record. The Numbers Pre 2007 the fund was a shining example that active management can work. 2007 in particular was a stand out year where the fund returned 34.42%, beating the S&P 500 by over 28%. Yes, the fund was concentrated and had a higher beta, it certainly brought alpha to the portfolio. Unfortunately, since 2008, the fund has been mediocre at best. (click to enlarge) Source: YCharts Even over the last 10 years, the fund has still not gotten its mojo back. (click to enlarge) Source: YCharts Putting this into perspective, we can take a look at the Risk Reward Scatterplot and MPT statistics for the fund compared to the S&P 500. (click to enlarge) Source: Morningstar While the fund has returned positive numbers, it has done so with both a higher beta to the market, and a lower alpha, not keeping up with the market. This trend holds true for both the 3, 5 and 10 year numbers. Our Take & Bottom Line This was a great fund Pre 2008, however during the great financial melt UP inspired by zero interest rate policy, active managers have been left behind as the entire markets went up. All you heard for the last 8 years has been index funds, ETFs, etc. Only this year have you started seeing a return to good active managers in a market that has gone nowhere for the year. The question is…. what does the future hold? Unfortunately, no one knows how CGM will manage in the future. The fund has typically had very active turnover in the portfolio with very little to show for it. It would not be prudent to invest in the funds right now, so this discussion focuses for those that are current investors. Even though Natixis will be liquidating the funds, CGM does have 3 mutual funds that are no load funds, as opposed to the Natixis CGM funds that were sold primarily through financial advisors. For investors who still believe in CGM and Kenneth Heebner, your choice would be to invest in the CGM Focus Fund (MUTF: CGMFX ) which mimics the Natixis fund very well. Unfortunately, the performance has been just as tepid. Perhaps this fund closing is just an opportunity to take a moment and reevaluate your options. In any case, it would be prudent to process your sell order now, rather than wait for the fund liquidation to happen by itself and hope to avoid any other special distributions & 1099s.

BUI: Thrown Out With The Bathwater?

Summary BUI is a closed end fund seeking total appreciation through capital gains and income, investing in utility and global infrastructure equities. BUI currently yields over 8% as its discount to NAV is near record highs. BUI is an atypical closed end mutual fund that has been discarded with the rest of the CEFS over the last 12 months. The BlackRock Utility & Infrastructure (NYSE: BUI ) closed end fund is an investment that I could of only wish for… on paper. BUI is an investment in one of my favorite asset classes (utilities and infrastructure), utilizing one of my favorite investment strategies (covered call writing), in one of my favorite investment fund structures (closed end fund). Unfortunately, since inception, it has been at best a mediocre investment, in particular over the last 12 months. Is the fund a bad fund? Or has the baby been thrown out with the bathwater? The Basics The BlackRock Utility & Infrastructure fund is a closed end mutual fund seeking income and capital appreciation by investing in equities of companies engaged in the utilities and infrastructure business. It carries a 1.1% expense ratio and invests in a portfolio of utility stocks that can be found in many other utility ETFs and mutual funds. What separates this fund from the competitors is the portfolio managers’ strategy of using/writing call options on the individual stocks in order to generate current income. In theory, this should reduce the overall volatility of the portfolio while providing current income. Currently it is paying a distribution rate of 8.57%. In rising markets, these types of portfolios tend to underperform the market as the upside is capped with the written call options. Let’s see how the portfolio has done. The Numbers Closed End Funds are a unique type of an investment that require extra care and attention. Unlike a traditional open end mutual fund that trades once a day, a closed end mutual fund trades like a stock and can be bought and sold throughout the day. Unlike traditional mutual funds which are priced once a day at the net asset value, closed end mutual funds trade a market prices, that may or may not be indicative of the true net asset value. For these reasons closed end mutual funds are typically more volatile compared to traditional funds, not because of the underlying performance, but rather on the reactions or over reactions in the market price. To understand this, you must also keep in mind that closed end funds, unlike their open ended siblings raise money once, and then they list on a public exchange and trade like a stock. If you as the investor want to invest money in the mutual fund strategy, you are buying someone else’s shares. The fund managers have that finite portfolio to work with and that is it, no new shares are created when you decide to invest your money. What this ends up translating into is most closed end funds trading at discounts below the actual value of the funds. That is why it is important to note the difference between the Market Price and the underlying Net Asset Value (NAV). In times of trouble, the market price may be significantly below the actual NAV, and may be a good opportunity to invest and buy assets on sale. Over the last 12 months, Closed End Funds have been hit quite hard with investors pulling out money. Typically, a closed end fund investor is looking for current income. The recent concerns about the health of the high yield markets as well as the interest rate hikes has caused fear and money flowing out of such investments. Unfortunately most people look at closed end funds as an asset class rather than as an investment vehicle with underlying investments. Has BUI been lumped in with other closed end funds? Let’s take a look. (click to enlarge) (Source: CEF Connect) As you can see, YTD BUI’s market price is down approximately 11%, however the underlying NAV is down only 6.99%. In essence, the investors were willing to accept less for the fund that what it was actually worth. In 2012 and 2013 you have had the same results. 2012 in particular resulted in a situation where the funds market price was down 3.51% for the year, yet the underlying net asset value was up 8.69%. 2014 showed what happens when people are chasing yield and were willing to pay more for the fund than what it earned where the market up was up 24.95%, yet the underlying NAV was up only 16.05%. An astute closed end fund investor looks for these opportunities to buy or to cash in their gains. On an annualized basis we have the following. (click to enlarge) (Source: CEF Connect) Since the fund launched in 2011, the total return including distributions averaged out to 3.43%. The fund has lost value, however it distributed a significant amount of dividends and income from the options. On a net asset value basis, the fund has performed respectably, earning an annualized 7.69%. Included are the performance numbers for the Closed End Fund Utilities category. What you can see is as expected, the fund has underperformed versus the peers, however during bad times, such as over the last year, BUI which uses no leverage and only generated income by writing call options was able to lower the volatility versus the peers as seen in the net asset value. Furthermore, while investors did notice this, you can still make the argument that this fund was hurt by the overall “dirty water” being thrown out as the market price did not hold up as well as the net asset value. The one place where this is evident is in the visualized chart of historical discounts and premiums to net asset value. (click to enlarge) (Source: CEF Connect) As of the time of writing, the fund is trading a discount of 13.24% to underlying net asset value. This has been historically a bigger discount than average, last seen late 2013 during the Fed’s Taper Tantrum. Conclusions and Final Thoughts Going through this analysis, it becomes more and more clear that unfortunately for this fund, it is lumped in with other closed end funds. Unlike other funds that employ leverage and invest in risky assets, BlackRock’s Utility & Infrastructure fund uses no leverage, buys globally listed equities, generates income with covered call options and has reasonable management fees. Unfortunately even though the underlying portfolio is seemingly performing as intended, the majority of investors are willing to overlook that and treat this as any other closed end fund. For a long term income investor looking for utility and infrastructure exposure, this fund at the current prices may be worthy of a look, at the very least put on your watch list.

Should You Stick With Duke Energy After A Rough Year?

Duke Energy has received the first two regulatory approvals to proceed with its acquisition of Piedmont. The annual average residential electricity sales will drop 0.5% in 2016, but the prices increase will offset the impact of unfavorable weather conditions. Duke Energy is trading at very reasonable valuation and offers a very attractive dividend yield of 4.58% at current levels. Duke Energy (NYSE: DUK ) has received the first two regulatory approvals to proceed with its acquisition of Piedmont Natural Gas (NYSE: PNY ). Now the approval of Piedmont’s shareholders and permission from the N.C. Utilities Commission is required to complete the transaction. So far the process has progressed smoothly, and Piedmont’s shareholders will meet on January 22, for that purpose. Duke Energy will become the largest gas utility in the state and N.C. Utilities Commission could raise concern over the dominance position, but the management expects to complete the transaction on time. Duke Energy, like most of the other utility stocks, underperformed during 2015 primarily due to uncertainty over interest rate hike. Now finally, Fed has raised the rate and would continue to hike steadily during 2016. The only downside of interest rate increase for Duke Energy is that incremental financial burden could restrict the earnings growth. In this scenario, the investor might be concern over the sustainability of future dividend payments. However, consistently growing regulated electric & gas operations and stout cash flow position will enable Duke Energy to bear the shock and continue to return cash to shareholders. So far this year, Duke Energy has delivered satisfactory performance despite very rough weather conditions. In the coming quarters, the outlook of unregulated utilities is likely to remain challenging primarily due to declining power and natural gas prices and soft electricity demand. On the contrary, regulated utilities will benefit from the supportive regulatory environment, resulting in steady operating earnings growth in 2016. While overall sector earnings are likely to grow 3.7% during, Moody’s (NYSE: MCO ) expects that regulated utilities will witness better operating earnings growth. Source: Factset Duke Energy’s regulated utilities segment recorded operating revenue of $17.09 billion, an increase of only $16 million year-over-year. The flat top-line was due to unfavorable weather during the first half of 2015, but the segment revenue increased 2.7% during the third quarter on the back of mid-single digit increase in electricity demand. Currently, the regulated electricity business is 91.3% of total revenue flowed by 6.4% nonregulated and 2.3% regulated natural gas. Going forward, the addition of approximately $1.4 billion annual sales from Piedmont will significantly increase the revenue contribution of Duke Energy’s existing regulate natural gas business. In the advantageous scenario, the aggressive acquisition of regulated assets will fuel the company’s earnings. (click to enlarge) Source: Company Presentation The commercial and industrial demand is steadily rising, but the mild weather is negatively impacting the demand for residential electricity. The Energy Information Administration (EIA) estimates that annual average retail residential sales will drop 0.5% in 2016, but electricity sales to the commercial and industrial sector will increase by 0.7% and 1.4%, respectively. Source: EIA Duke Energy may continue to witness flat residential usage per customers owing to stable demand and improving efficiency level, but an increase of 0.7% in residential electricity prices will support the growth during 2016. Moreover, the diversified customer base and the addition of new residential customer at a low single-digit, the company added 1.3% new customer over the past twelve months, will boost the top-line at a steady pace. On the other hand, the potential ease in currency headwind and divestiture of poor performing assets could also improve the revenue from international operations. Thus, the trickling down of revenue growth, solid gross margins, and a massive $10 billion investment in gas & electric infrastructure will enable Duke Energy to accelerate an average long-term earnings growth of 4% – 6%. Duke Energy pland to invest approximately $20 billion in new generations and infrastructure development between 2015 and 2019. So far, the company has spent $4.64 billion in CAPEX during 2015, while it generated $5.4 billion in operating cash flow with cash & cash equivalent of $1.37 billion cash. The cash flow position looks pretty healthy, which depict that the company would be able to manage CAPEX and dividend payments without any cut if the interest rate increases further. Duke Energy increases dividends each year, and it has paid the quarterly dividend for 89 consecutive years. Duke Energy is one of the high yield utility stocks and currently, it offers a yield of 4.58%, significantly higher than the average 3.90% yield of large-cap electric utilities in the U.S. Duke Energy has increased the dividend at a CAGR of approximately 2% between 2009 and 2014. Now, the company has recently boosted the increase rate to 4%. The management expressed the intention to increase the future dividend more in line with the long-run earnings growth, which is 4% – 6%. Though interest rate is a threat, the healthy balance sheet will enable the company to maintain the dividend growth. Source: Finviz The balance sheet of the company is very sound with total assets of $121 billion. In contrast, the company has a total debt of $40.2 billion. The debt would increase in 2016 owing to partial debt financing to complete the acquisition and additional debt from Piedmont. Despite the substantial debt, the company’s financial health is likely to remain rigorous as it invests in quality assets to generate growing cash flows, and its total debt to asset ratio, excluding goodwill, is only 0.38 times. Currently, the total debt to equity ratio of Duke Energy is 1.07 times, which seems quite high but is significantly lower than the large-cap electric utilities average and median of 1.38 times and 1.21 times, respectively. Moreover, the interest coverage ratio of 3.85 times depicts that Duke Energy is in a very comfortable position to cover the future interest expense while raising the dividend in line with the earnings growth. Duke Energy delights the investors by raising dividends, which are backed by consistently growing earnings. Unfortunately, Duke Energy is one of the stocks to lose double-digit value during 2015 primarily due to interest rate turmoil throughout the year. On the flip side, Duke Energy is now trading at very reasonable valuation, and its yield has increased due to a steep decline in share price. Duke Energy is currently trading at forward PE of 15.31x, which is slightly less than the utility sector forward PE of 15.5x. That said, Duke Energy is a very decent utility stock to hold for growing dividends and investors should not worry about the interest rate as it is already priced-in.