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Utility CEFs Are A Diverse Group But There’s Not A Buy Among Them

Summary Utility CEFs include the wholly domestic, wholly international and funds that include a mix of each. Utility CEFs also include funds that are entirely listed equity as well as funds that invest in equity and utility market debt instruments. Yields range widely, from 6% to over 10%. The sector has had a difficult year and it does not look likely that there is a turnaround in the offing. Closed-end fund categories tend to encompass a more diverse clustering of funds than comparable categories for the other fund types. This is especially the case for utilities. The category includes funds that are wholly domestic to funds that have only international holdings. There are funds whose portfolios are entirely listed equity and a spectrum that ends with only half the portfolio in equity. It really isn’t a category that can be considered as a whole from which one might attempt to pick the best fund or fund; rather it’s a category that offers a range of alternative investment choices under a broad heading of utilities and infrastructure. In light of that diversity, I thought it was worth a look to see if there might be opportunities in the category. Utilities have not had a good year. In fact, year-to-date, domestic utilities are lagging every sector except energy. And, to the extent that they are more interest-rate sensitive than other sectors, one might predict another less than stellar performance from the category in the months ahead. Or, one might take the view that the marked underperformance of recent months, suggests a timely entry point may be at hand as we approach year-end tax-loss selling which can generate bargains. It’s my goal here to lay out an overview of the category which comprises nine funds. These are: Blackrock Utility & Infrastructure Trust (NYSE: BUI ) Cohen & Steers Infrastructure Fund Inc (NYSE: UTF ) Duff & Phelps Global Utility Income Fund Inc. (NYSE: DPG ) Gabelli Global Utility & Income Trust (NYSEMKT: GLU ) Gabelli Utility Trust (NYSE: GUT ) Macquarie Global Infrastructure Total Return Fund Inc. (NYSE: MGU ) Macquarie/First Trust Global Infrastr/Util Div & Inc Fund (NYSE: MFD ) Reaves Utility Income Fund (NYSEMKT: UTG ) Wells Fargo Advantage Utilities & High Income Fund (NYSEMKT: ERH ) Let’s start with a picture of how the domestic utility sector performed over the past year. This chart shows total return for two domestic CEFs (GUT and UTG) and the Utilities Sector Select SPDR ETF (NYSEARCA: XLU ), a proxy for the domestic utility sector. (click to enlarge) As I said, utilities have had a rough year. And that sharp drop for XLU, especially at the end of last week, is an indication of investor anxiety over the impact of interest-rate hikes on the sector. It’s not clear if this downward pressure on utilities will continue, but the thing about CEFs that we see again and again is that when an investment category is under stress, those stresses tend to be exaggerated in the CEFs that cover the category. Add that to the traditional year-end downward price moves common for CEFs and I felt that the category may bear careful watching by bargain hunters. Portfolio Composition I think the best place to start is with the nature of the funds. I’ve been considering the sector from a purely home-bias point of view so far, but except for the two funds considered above, GUT and UTG, the CEFs in this sector carry substantial international exposure. The next chart shows how much domestic exposure each of the nine funds has. (click to enlarge) The global funds vary from 63% to less than 1% domestic exposure. International utilities may be an attractive income alternative to domestic utilities if interest-rate anxieties continue to batter the domestic sector. It is, however, a difficult category for most investors to penetrate. The global CEFs offer the most accessible opportunities for doing so. The other variable aspect of the portfolios for these funds is the extent of investment in listed equity vs. debt and credit. This chart shows the level of equity with the remaining non-equity components including bonds, other debt, preferred shares, and cash equivalents. (click to enlarge) As we see, GUT and UTG are, in addition to being domestic funds, wholly invested in domestic equity. These are the sorts of funds many of us might think of when we consider a fund in the utilities sector. ERH and MFD, by contrast, show approximately half domestic and international exposure in their holding and divide their portfolios approximately 50:50 or 60:40 between equity and debt instruments. A third important difference among CEFs in a category is the amount of leverage they carry. CEFs typically seek to enhance performance, especially distribution yield, by using leverage; utility CEFs are no exception. (click to enlarge) All but one of the funds are leveraged over a considerable range. BUI is essentially unleveraged and GLU carries 37% leverage. Distributions CEFs, regardless of category, are primarily about income, and utilities is the traditional equity sector most strongly associated with income investing. This is, of course, why utilities are more interest-rate sensitive than almost any other equity sector. The next chart shows distribution yields for the nine funds at market price and at NAV. (click to enlarge) Market yields range from a low of 6.3% to a high of 10.7%. I find it interesting that yields correlate poorly with leverage. (click to enlarge) As we see here, there is essentially no meaningful correlation at all between leverage and yield (r2 = -0.057) and, in fact the trend is negative. By this measure GUT and, to a lesser extent, MFD provide strong returns (as yield) relative to their effective leverage. Another widely seen trend in CEF categories is the positive correlation between NAV yield and discount. This is a consequence of investors’ willingness to pay for yield. Funds with high NAV yields tend to be bid up relative to funds with lower NAV yields. When NAV yields are especially high, prices tend toward premiums to NAV. Some observers consider that there is a tendency for funds in a category to move toward a sort of equilibrium market yield by adjustments in discount/premium valuations. The next chart plots the two variables and, as is typical, the slope of trendline is positive and the correlation is reasonably high (r2=0.539). (click to enlarge) Funds that fall below the trendline on this chart tend to merit attention when looking for an entry point for a purchase. The assumption behind that logic is that the discount/premium will adjust upward for such funds. MFD is the best situated fund on this measure. Discount/Premium Status Currently all but two funds are priced at a discount. UTG has a small premium (0.96%) and GUT has a large one (15.80%). Discounts range from -7.5% to -16.1% . (click to enlarge) The next chart plots 3, 6 and 12 month Z-scores for the funds. Recall that Z-scores describe the current premium/discount status relative to the range over the period being considered. A negative Z-score indicates a discount (or premium) more negative that the average; positive Z-scores indicate the opposite. The value of the Z-score is best understood as the number of standard deviations the current value is from that average. (click to enlarge) What we see is that for 3 months every fund has a positive Z-score. Discounts have been reduced over the period. For one year, all but one fund have negative Z-scores. This tells us that discounts have been on a pattern of being reduced over the year. UTG’s current discount is nearly 3 standard deviations from its 12 month average, and the most negative Z-scores, for UTF and MGU are -1.2 for the year. This is not a pattern one associates with bargain pricing. Recent Total Return Performance From the pattern of discount/premium movement one might expect that the funds have been performing well over the 12 months that discounts have been compressing. But such is not the case at all. As we see here, total return for the entire category for the past 12 months has been negative at market pricing, and only four of the nine funds are positive for NAV return. (click to enlarge) Conclusions I will not have very satisfying conclusions here. The sector has been battered and prospects for a near-term turnaround are looking glum in my opinion. By many of the metrics, but one, GUT looks like very appealing. But with a 15.8% premium, I’ll avoid it, particularly as that premium exists for a fund that’s lost 6% on NAV over the past 12 months. The appeal of this category is the opportunity to get international exposure, so I’m more inclined to look closely at the global cohort. These have seen large declines at NAV. DPG, which is an equity fund, and MFD, equity and debt, are down 2 to three times as much as the domestic funds on NAV although their prices at markets have not suffered as badly. ERH, with the highest percentage of debt holdings doesn’t look too bad relative to the rest of the lot, but is this really a time to move into fixed-income? Finally, I should add that UTG, one of the long term standouts in this category, is anticipating another rights offering to expand the fund. I would not suggest opening or adding to a position in UTG at least until the dust settles on that offering. All too often when a CEF expands it is unpleasant for current shareholders. Henry Nyce discussed this in detail last week ( here ) and I agree fully with his conclusions. Add to all of this the fact that the discounts have been closing and I don’t see anything appealing here at all. I find it odd that in the face of such poor performance the discounts have been moving in the direction they have, but such is the case. It’s possible that year-end tax-loss selling can change the picture, in which case the broader information I’ve pulled out here may be useful, but until then, I’ll pass on the category.

Reaves Utility Income Fund: Coming Dilution Will Likely Drive Down NAV And Market Price

Summary Management has recently filed for a rights offering with SEC. The rights offering is an offer to sell more shares, which will lead to further dilution of NAV and the market price of UTG. The current downward spiral of NAV along with rights offering suggests investors would be better served by avoiding UTG. ( click to enl arge) I wrote about Reaves Utility Income Fund (NYSEMKT: UTG ) back in July, suggesting that it offers a relatively safe 6% yield paid monthly. In that article, there was a table that showed that UTG had outperformed both the S&P Utilities Index and the Dow Jones Utility Average over a 5-year period ending 4/30/2015. However the fund has not been performing as well this past year. On that same chart, total return was a -0.17% for six months, whereas the S&P Utilities index returned -1.10% and the Dow Jones Utility Average returned 3.78%. A copy of the table is shown below: (click to enlarge) Source: UTG Semi-annual Report Reuben Gregg Brewer wrote 2 articles on UTG over the past several months that indicate things are not going well at this CEF. You can read these articles here and here on Seeking Alpha. In the first article, he reports that NAV is down 11.5% for the year and that market price is down 13%. He shows some concern in the article that UTG will have to do a ROC (Return of Capital) to maintain the dividend if things don’t turn around soon. UTG has been able to avoid making ROC dividend payments over the past few years. He maintains a positive attitude toward the CEF in this article in spite of the bad news while at the same time predicting a lower price. His last 2 statements in the first article are: ” That said, if you are looking for a bargain, I don’t think UTG is there just yet. But with market volatility kicking up, keep a close eye on UTG, because fickle investors may just give you the opportunity to buy in on the ‘cheap’.” The second article chronicles the rights offering that UTG is about issue to stockholders. On 10/6/2015 UTG announced that it filed with the SEC to offer additional common shares of the fund pursuant to a rights offering. One right per share will be given to each shareholder and 1 share of UTG can be purchased for every 3 rights held. UTG also has the option to issue up to 25% additional shares based on the common shares issued in the rights subscription. Reuben Brewer offered the opinion that this offering would work out for shareholders in the long run. He wrote: “If you are a Reaves shareholder this is probably a good deal for you. Will it be a good deal in the next six months? Maybe, maybe not. But longer term the CEF appears to be of the opinion that now is a good time to put money to work. And that should work out for you if you plan to stick around for some time.” Levis Kochin violently disagreed with Brewer in the comments section by stating that the rights offering is a reach for more management fees by Reaves Asset Management. He asserted further that this offering is stealing NAV from current shareholders by offering shares below NAV. Kochin is correct in that the rights offering is a further dilution of NAV and is not in the best interests of stockholders. To see the rights offering as a positive requires one to have a great deal of faith in the managers of the fund. Mr. Brewer believes management will use these additional funds to purchase shares of beaten down dividend companies and that it will eventually work out to the best interests of shareholders. He believes that history will repeat itself when it worked out well for shareholders the last time UTG did this in 2012. Operations this year has NAV dropping at about 1% a month. The Market price of UTG has dropped faster than NAV. As of 9/30/15 NAV has dropped 9.85% and the market price has dropped 10.93%. The performance table from UTG is shown below: (click to enlarge) Source: Reaves Utility Income Fund Website (performance) Conclusion: I am currently negative on UTG because of the impending dilution coming with the rights offering and the increasing number of available shares. The distribution of more shares will likely cause an imbalance of shares offered to sell as opposed to offers to buy. Both the NAV and market price of UTG will likely be soft for the next 6 to 12 months. Therefore I would definitely not be a buyer at the present time. But if you already own UTG, you may wish to hold on to keep collecting the monthly dividend and to wait out management hoping it will invest the new money wisely. In the accounts of retired folks, I let the investment ride to collect UTG’s monthly dividend. For folks that are not retired, I sold the issue and moved the money to other investments that appear more positive over the next few months.

BUI: Has It Held Up In The Downturn?

I looked at BlackRock Utility and Infrastructure Trust not too long ago. Comparing it to UTG, the big difference was the use of options versus leverage. Is that not so subtle difference playing out as expected? One of my favorite utility and infrastructure closed-end funds, or CEFs, is the Reaves Utility Income Fund (NYSEMKT: UTG ). But it’s far from the only fund out there that focuses on this space, which is why readers asked that I look at the BlackRock Utility and Infrastructure Trust (NYSE: BUI ), a much younger entrant in the space. At the time I first looked at the two together I said I liked UTG better, but that BUI theoretically should hold up better in a downturn. Well, it’s time to look at how that’s playing out. Similar, but different UTG and BUI both invest in the infrastructure that makes our modern world work. That includes electric companies, but also things like water utilities, oil companies, airports, and railroads. Both take a pretty broad look at their niche. But, in the end, they both are looking to do a very similar thing. However, that doesn’t mean their portfolios are alike. For example, at the end of June, the energy space made up around 6% of UTG’s portfolio. That number at BUI was a far more meaty 24%. So similar, but different. Which is to be expected since the CEFs are offered by two different sponsors. However, there’s another notable difference here, too. UTG attempts to enhance returns via the use of leverage. BUI looks to boost returns, specifically income, via the use of an option overlay strategy. In a flat to slowly rising market these two approaches should probably produce similar results. In a fast rising market I’d expect UTG’s leverage to result in better returns. And in a down market, I’d expect BUI’s use of options to soften the blow of the decline. That’s what I’d expect, anyway. Now that we’ve seen the utility and other income-oriented sectors fall this year, what really happened? A mixed bag Year to date through August, the net asset value, or NAV, total return for UTG was a loss of 9.3%. BUI’s loss over that same span was a more mild 6.7%. On an absolute basis that’s not such a big difference, but on a percentage basis BUI “outdistanced” (perhaps under-lost?) UTG by around 25%. That’s a pretty big difference. All return numbers assume the reinvestment of distributions. So, on the whole, I’d say that the option overlay did perform as expected. To stress the point, the Vanguard Utilities ETF (NYSEARCA: VPU ) was also down over 9% over the year-to-date period through August. But pull back some and things get a little more interesting. Over the trailing year through August, VPU was essentially break even. UTG, meanwhile, was down 3.3%. BUI was down roughly 5.5%. What gives? For starters, both UTG and BUI have broader investment mandates than VPU. And UTG and BUI are stock pickers, using human intelligence (or not, depending on your opinion of active management) to select stocks. Put another way, VPU has a much tighter focus on utilities. It also doesn’t use leverage, which through a good portion of the time was a drag on UTG’s performance. So I can understand why it did better than BUI and UTG over the trailing year, which has been a pretty turbulent time in the markets for some of the additional areas in which these two CEFs have ventured. But why has BUI underperformed UTG by so much over the trailing year? The answer is most likely the previously mentioned weighting difference in the energy sector. Oil prices, and the stocks associated with the energy sector, started to fall around mid-2014. So, it makes sense that BUI, with a much heavier weighting in the sector, would be hit harder over the trailing year period. And it’s hard to say that the oil downturn is over, yet, either. Which adds a notable amount of risk to owning BUI relative to UTG. Who wins? So, in the end, this difficult period isn’t a clear win for BUI or for UTG. It kind of depends on what period you’re looking at and how you define success. For example, looking even further afield, BUI was down 5.5% over the past year, but that was much better than the Vanguard Energy ETF (NYSEARCA: VDE ) which was down over 30% even though BUI underperformed utility-focused VPU, which was pretty much break even over the span. If you liked the extra oil exposure BUI offered versus UTG when oil was doing well, it’s hard to complain when it starts to work against you. And then there’s this year, when utilities took a hit and UTG underperformed relative to BUI. With leverage adding a helping hand to the downside along the way at UTG and option income softening the blow at BUI. So the use of options did, indeed, appear to do what you’d expect. I still like UTG. It’s a solid fund with a long history of navigating volatile markets and rewarding shareholders along the way. BUI is really seeing its first serious stress test. That said, I think it’s holding up pretty well. And, at the end of the day, I don’t think either is a poorly run CEF. Looking at the two today, UTG’s discount is narrower than normal at around 2%-about half the normal 4% or so over the trailing three years. It isn’t cheap, but then investors are likely rewarding it for its strong historical performance. A flight to safety, if you will. BUI, meanwhile, is trading at a roughly 13% discount versus its trailing three-year average discount of 9.5% or so. It’s clearly the cheaper of the two funds. BUI is also offering a more generous distribution yield, at 8.6%. UTG’s distribution yield is a more modest 6.4% or so. Neither is outlandish, but UTG’s lower yield is likely to be more sustainable over the long-term. That said, if you are looking for yield and prefer wider discounts, BUI looks like the better play-but only if you believe the oil market has stopped falling… If you are conservative, UTG is still the one to watch. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.