Tag Archives: city

Summary UTES, a new ETF offered by Reaves Asset Management, is the first actively managed utilities ETF. Reaves intends to use its 37 years of experience with the utilities sector to build a portfolio that will feature growth. I was able to interview Joseph (“Jay”) Rhames, the fund manager, to get insights into the philosophy behind this fund. Utilities are one of the more popular sources of income for investors, with yields typically in the 3.00% – 5.00% range. Utilities are attractive because they are a defensive investment – these are the sort of companies that are constantly in demand, in terms of what they provide – namely, power . Everyone uses it, everyone needs it; everyone pays for it. In terms of growth , however, this may not be the most attractive segment of the market. As noted by one colleague, prices for utility stocks rose from the period of 2008 – 2014 primarily due to the fact that other sources of income (CD’s and money markets) were not offering much. 1 However, along with everything else in recent months, utilities have seen a drop in value. The extent to which this is associated with the general market declension remains to be seen, but utilities are not usually known for rapid growth, anyway. As an industry, utilities are usually regulated by local and state authorities, and regulators do constitute an effective cap on a utility’s potential growth. The Utilities ETF As we will see later in this article, ETFs do offer an interesting means of achieving effective yield from utilities. Until recently, all utilities ETFs have been passive, indexed funds; in September, however, Reaves Asset Management – a company that has been managing institutional portfolios since 1978 – decided to put its experience in the area of utilities behind an actively managed fund: the Reaves Utilities ETF (NASDAQ: UTES ). 2 Historically, Reaves has been intimately involved with the utilities sector, and has extensive experience working with utility management companies. UTES represents their effort to translate that experience into a marketable ETF that can improve growth prospects over those of passive funds. In preparing this article I had the opportunity to speak with fund manager Joseph “Jay” Rhame, III , about plans for the fund. 3 I came away impressed with the depth of understanding Reaves has of utilities and their awareness of the factors currently influencing the business. Selection UTES currently has 21 holdings, or about one-fourth the holdings of larger ETFs and fewer than half as many as the average for the eight other utilities-focused ETFs. No index is used in the selection of the holdings; Mr. Rhame is focusing on companies that are profitable , that may be underweight , and – in particular – companies that are oriented towards utilities infrastructure , rather than power generation. For purposes of the fund, a company constitutes a ” Utility Sector Company ” when either 50% of the company’s assets or customers are committed to, or at least 50% of the company’s “revenue, gross income or profits” are realized from “products, services or equipment for the generation or distribution of electricity, gas or water.” 4 Companies that are focused more towards power generation are subject to pressure from regulators who control prices; as a result, their share prices tend to be volatile , fluctuating according to changes in the regulatory environment. Infrastructure, on the other hand, is a more stable operation with regular demand and less influence from regulators ; this makes their business more reliable , improving prospects for share prices. Furthermore, the fund seeks (primarily U.S.) 5 holdings that display at least one of the following characteristics: They have conservative capital structures. They present solid balance sheets. They have a history of, and/or the potential for, growing earnings or raising dividends. There are positive catalysts that could potentially unlock value. Their levels of volatility, correlation or similar characteristics are lower than market levels. 6 Eligibility is independent of the company’s market capitalization; further, companies may be evaluated on earnings/cash flow potential, dividend prospects, strength of franchises and estimates of net asset value. 7 Weighting There is no formal weighting system for the holdings; rather, holdings are evaluated on their growth potential and relevant developments that may affect the companies and their performance. According to Mr. Rhame, this enables the fund to be weighted towards those companies which are seen as having the greatest prospects. The intention is for the management to have the flexibility to shift assets as changing situations warrant. The fund would be subject to reconstitution and rebalancing at the discretion of the portfolio manager. Dividends Based on the fund’s current holdings and the dividends paid by those companies, I have estimated that UTES will be paying a little more than $0.61/share . This figure is based on dividend income the fund is projected to receive; the fund could realize additional income in the form of capital gains , interest , etc. The fund should see close to $90,000 in gross income from dividends, giving it a realized yield of 3.22%, based on current NAV. This is in keeping with the average yield of 3.33% amongst its holdings. Given its expense ratio, the fund should see a return on NAV of 2.27%. Mr. Rhame did affirm that the fund would not use derivatives or other instrumentalities (options, shorts) to increase yield. He is satisfied that the approach they are taking will result in greater growth, and he is inclined to invest in those companies having lower yields where it indicates price growth is most likely to occur. He projected yield in the neighborhood of 2.5% , which is consistent with my projections which indicate a yield of approximately 2.31% . Dividends are expected to be distributed quarterly, with capital gains being paid at least annually. 8 Testing the Portfolio As usual, I like to take the portfolio of a new ETF for a “spin,” running its holdings into the past to see how the portfolio might have performed had it been in existence. This “pseudo portfolio” is not used by way of a claim that the results would have been true had UTES been in existence – only that the companies in the portfolio did actually perform in said manner. As usual, past performance should never be taken as an indication of future activity. I ran the portfolio back to 1 January 2005, and seeded it with $10,000. Due to the proprietary nature of the weighting of UTES’ actual portfolio, I opted to weigh the holdings equally. The portfolio was rebalanced every six months. Because utilities are largely used as means of acquiring yield, I ran the test twice: once using the actual closing prices from January 2005 to the present, and once using the adjusted closing price, which reflects a company’s dividends and stock splits for the period covered. 9 The following chart illustrates the portfolio’s performance on both accounts: (click to enlarge) As one can see, there is a marked difference between the return realized in terms of share price alone, and the total returns one would expect once dividends are figured in. The main value in such a portfolio is to be had by holding it for the long term, pulling in the yield, rather than anticipating significant growth of share value. Comparison The portfolio of which UTES is comprised looks to be productive; the question remains whether it is competitive with what is out there now. Besides UTES , there are 10 other ETFs that focus on utilities, 10 with a range of portfolio sizes and offering a range of yields that seem, on first blush, to be superior to that offered by Reaves ‘ fund. For sake of comparison, I have chosen four funds to run side by side with UTES . The funds are: Vanguard Utilities ETF (NYSEARCA: VPU ) iShares U.S. Utilities ETF (NYSEARCA: IDU ) Utilities Select Sector SPDR ETF (NYSEARCA: XLU ) Guggenheim S&P Equal Weight Utilities ETF (NYSEARCA: RYU ) These ETFs were tested using the same procedure as that used for the UTES portfolio. They were run with both the actual closing costs and the adjusted closing cost. The chart for the actual closing cost follows: (click to enlarge) Although the UTES portfolio drops off in the early stages of the trial it comes back to lead the other funds, beating VPU handily by 785bps. RYU has an inception date of 1 November 2006, and that has no doubt adversely affected its comparison in this trial. As one might expect, the ETFs tend to bunch up together (other than RYU ) The following chart represents the adjusted closing price: (click to enlarge) As earlier, RYU’s performance is well back of the other ETFs. IDU , XLU and VPU are grouped together, just as they were in the previous trial – still within about 600bps of each other. The UTES portfolio, however, outperforms VPU by 77 full percentage points (7700bps). The extent to which this is due to the fact that there is no internal loss of income in the portfolio – as is the case with the ETFs – is not clear, although no doubt were the portfolio an actual ETF, its returns would be more than marginally moderated. Some Additional Considerations I asked Mr. Rhame directly how he thought their active management of UTES would set it apart from the passive funds it competes against. His response focused on the fact that Reaves was in a position that enabled them to put their experience to work. They were familiar with the issues facing various companies, the effectiveness of companies’ management, and the prospects each company had. As examples of their ability to put their knowledge of companies to use, he cited the following: Atmos Energy Corp. (NYSE: ATO ): This company is involved in the gas pipeline business. One of the largest natural-gas-only distributors in the U.S., and located in Texas, Atmos is involved in a long-term pipeline replacement project that assures the Company of regular rate increases to cover its costs. On 4 November 2015, the Company announce it would raise its dividend by 7.7%, to $1.68 from $1.56. 11 DTE Energy Holding Co. (NYSE: DTE ): Located in Detroit, DTE is one of the best-managed utility companies in the country, according to Mr. Rhame. The Company is one of the largest employers in Detroit, and is heavily involved in efforts to revitalize the city. The Company is committed to keeping its utility costs low; its efforts are recognized and supported by the Michigan state government. Both companies are in the fund’s portfolio ( DTE is the fourth-largest holding). Mr. Rhame also expressed Reaves’ commitment to making UTES completely transparent , a concern many investors have when considering actively managed funds. I do have some reservations about the yield UTES seems positioned to offer. A yield of 2.31% (if my estimation is correct) is significantly lower than that offered by other ETFs. Growth prospects would have to be pronounced if they are to compensate for the lower dividends. Of course, the primary influence on how much of its income a fund is able to distribute to shareholders are the fund’s expenses. The following graph shows how the funds in the graph above compare in this regard: [*Note: again, I must point out that dividend figures for UTES are my projection, and discussions thereof must be considered in that light.] Clearly, the premium exacted by UTES takes a toll on the dividends it is able to pay out; the expenses for actively managed funds is, as a rule, higher than that of passive funds, and UTES is on the lower side of active funds. Key to UTES success, again, is going to be whether the active management justifies its higher costs by bringing value into the fund. If that value is not going to be in the form of dividends, it will have to be by virtue of the value of the shares in its portfolio – either UTES will have to grow in value or it will have to return substantial capital gains to its shareholders. One last point needs to be made. Utilities tend to have high debt-to-equity (D/E) levels; on the whole, utilities as a sector have an average total-D/E of 1.55 , up noticeably from the average of 1.42 for the past three quarters. 12 The companies currently held by UTES have an average D/E of 1.20 . No doubt regulatory controls influence the level of debt these companies have, and Reaves’ strategy of focusing more on the infrastructure-related companies, which may encounter less regulatory influence than power-related companies, is a good one. Assessment I think it is clear that UTES has the potential to be a very profitable holding; however, the difference between it and other utilities ETFs is going to rest on the ability of its managers to effectively populate its portfolio with stocks that increase in value . The dividends to be realized from the fund will be good, but may not be as good as those offered by other utilities funds. Given Reaves ‘ extensive background in tracking the utilities sector, I am confident that this would be the right group to manage a portfolio on a day-to-day basis. Their current portfolio reflects a choice of holdings that have noteworthy potential . It might serve well to give this ETF a few months as a sort of shakedown before buying, and then buy shares gradually. Disclaimers This article is for informational use only. It is not intended as a recommendation or inducement to purchase or sell any financial instrument issued by or pertaining to any company or fund mentioned or described herein. All data contained herein is accurate to the best of my ability to ascertain, and is drawn from the Company’s Prospectus, Statement of Additional Information, and fact sheets. All tables, charts and graphs are produced by me using data acquired from pertinent documents; historical price data from Yahoo! Finance . Data from any other sources (if used) are cited as such. All opinions contained herein are mine unless otherwise indicated. The opinions of others that may be included are identified as such and do not necessarily reflect my own views. I would like to thank Mr. Rhame for kindly providing his view of UTES. Before investing, readers are reminded that they are responsible for performing their own due diligence; they are also reminded that it is possible to lose part or all of their invested money. Please invest carefully. ————————— 1 The Yield Hunter on utilities . 2 Data in the table includes projections that are based on my research into UTES and its holdings. In particular, income and dividends/yield are my projections based on dividend income I project UTES to receive from its holdings. Income yield (Inc. Yield) is reached by dividing gross income by NAV; return on NAV (RoNAV) is determined by dividing net income by NAV. Expense margin represents the portion of income that is left after expenses are subtracted from gross income. The fund’s website is here . 3 I spoke with Mr. Rhame by phone on 21 October 2015. All mentions attributed to Mr. Rhame refer to this call. 4 Prospectus, Reaves Utilities ETF ( UTES ), p. 4. 5 Many of the funds’ holdings are multinationals headquartered in the U.S. 6 Prospectus , p. 4. 7 Prospectus , p. 4. 8 Prospectus , p. 12. 9 I need to make a qualification here. The returns realized from the perspective of a portfolio of holdings, each one paying dividends directly to the portfolio holder, will be larger than the returns one would realize from an ETF, where dividends are paid to the fund’s management who then covers expenses with that money, distributing the remainder to the fund’s shareholders. With this in mind, I need to point out that the returns from the portfolio being considered is perhaps significantly higher than the returns from UTES would be. 10 Two of the available funds are leveraged “ultra”-style ETFs. 11 This is also the 28th consecutive year in which the company has increased its dividend. Atmos press release . 12 Data from CSIMarket.com .