Tag Archives: closed-end-funds

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.

Ozymandias On The Street: The Fall Of The Mighty In Fixed-Income CEFS

Taxable fixed-income, closed-end funds have fared poorly in 2015. Highly visible distribution cuts by category leaders have been followed by sharp selloffs and price declines with very high premiums falling to discounts. There may be opportunities in taxable, fixed-income funds although one might want to wait for a decision on interest rates before taking any action. It took a long time but the market has finally decided that the PIMCO High Income Fund (NYSE: PHK ) is not worth a premium. After running a premium in the stratosphere for seven years, PHK closed below par today, just five months after running a premium of 66%. PHK was clearly a house of cards. It was earning less than 65% of its distribution. But investors stuck with the fund and even defended it vigorously long after the writing was on the wall. A distribution cut was inevitable and when it came it wiped the premium off the board. On Sept 1 the fund announced a 15% cut in its distribution. Now, two weeks later (Sept 14), what had been the second highest premium in fixed-income CEFs is gone. This chart shows PHK’s premium/discount history. What you may not realize is that the right side does not show a vertical cut-off of the mountain at the end of the chart; that’s a vertical drop to near-zero. Interestingly, if someone buys the fund at today’s discount, the yield will be 17.4% until PIMCO drops the distribution further. It was that sort of return that driving the premium, and I’d not be surprised to see that premium moving up between now the next cut. Some might argue that with that distribution there is an opportunity, but I’m certainly not among them. Continuing to deliver that distribution after September (ex-date was Sept 9) at today’s -0.43% discount, will mean PHK has to pay out 17.3% on its NAV [Distrib NAV = Distrib Price /(1-(Premium/Discount)]. So, if PHK was a house of cards, parts of that house remain standing. And inevitably they must fall. Look for another distribution cut soon. For those of us not invested in PHK, there is a lesson here. One might choose to avoid all closed end funds, especially in this time of market uncertainty. And the steady declines in fixed-income CEFs ( discussed here ) says that many may have taken that tack. To my mind there is real opportunity in this market even though returns have been dismal and discounts continue to grow. Identifying those opportunities with confidence is going to be tricky however. I’ve written several times about the PIMCO Dynamic Income Fund (NYSE: PDI ), most recently this week . It is, in my view, well poised to provide strong returns in the near- to mid-term future. One of its qualities, which so many funds in this category lack at present, is that it is earning its distribution handily. Its current undistributed net investment income or UNII as a percentage of its distribution is the highest in the category, a category where 55% of funds are failing to cover their distributions from investment income. What other funds might be attractive on this metric? Right now, the strongest subcategory looks to be mortgage bond funds. I’ll be discussing this group in detail shortly, but I’ll mention a few highlights here as preview. The Western Asset Mortgage Defined Opportunity Fund (NYSE: DMO ), the BlackRock Income Trust (NYSE: BKT ) and the First Trust Mortgage Income (NYSE: FMY ) are standouts for their positive levels of UNII. FMY’s modest market cap and volume make it somewhat problematic in terms of liquidity, which is always a consideration in CEFs. DMO and BKT fare better on liquidity metrics. DMO is paying a 10.2% distribution yield; BKT’s is 5.9%. DMO has the best 1yr return on NAV in the category and it has recently dropped to a small discount. Anyone interested might want to start with a hard look at DMO. PDI is another consideration in the mortgage space. Although not a mortgage bond fund its present portfolio (30 June 2015) comprises 66% mortgage securities, so today it is two-thirds of one. The potential advantage is that if mortgages go south, PDI’s management has the flexibility to move out as readily as they moved in. What about those with existing positions? My advice to anyone invested in fixed-income CEFs is to take a look at the NII status of their holdings to see how well the fund is earning its distribution. Negative UNII alone does not necessarily mean one should sell a fund, but a persistent negative on this metric is a most worrisome sign. It could well mean that one should start looking for a suitable exit point. Waiting until distributions are cut to bring them in line with NII can be devastating not only to income, but to the value the portfolio as well. I’ll add as an aside that the value of UNII as an indicator of a fund’s status and distribution stability does not transfer to many of the equity funds. Details are outside the scope of this discussion, but I’ll note many solid equity funds, especially those that use options (option-income or buy-write funds), routinely show negative UNII and its evil twin, Return of Capital. They can even be a part of a fund’s investment objectives as they can create tax-advantages to the shareholder. It’s not clear what the Fed will do this week, but should they finally decide to raise rates, expect a move out of many of the fixed-income funds and sharp increases in the absolute values of discount. That may well be the best buying opportunity since the infamous taper-tantrum. Time spent now searching out quality funds may be rewarded. Disclosure: I am/we are long PDI. (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.

Cushing MLP Total Return Fund: A Lesson For CEF Investors

Summary CEF investors are often attracted by the high yields in this space. SRV’s anomalously high yield and premium provided a ripe recipe for disaster. This article identifies three warning signals that investors could have heeded before the devastating event. The date is Dec. 22nd, 2014. With oil prices collapsing around you, you decide that now would be a good time to dip your toes in an MLP close-ended fund [CEF]. You read Stanford Chemist’s just-published article entitled ” Benchmarking The Performance Of MLP CEFs: Is Active Management Worth It? “, where he recommended, among five MLP CEFs yielding 5.43% to 6.85%, the Tortoise Energy Infrastructure Corporation ( TYG ) due to its strong historical total return and outperformance vs. the benchmark Alerian MLP ETF ( AMLP ). But the 5.43% yield of TYG and the 6.25% yield of AMLP are a bit low for your tastes. You decide to invest in the Cushing MLP Total Return Fund ( SRV ) with a whopping 14.02% yield , more than double that of the other two funds. With twice the yield, you might expect twice the return, right? Fast-forward to today. You have lost half of your investment. The following chart shows the total return performance of SRV, TYG and AMLP since Dec. 2014. SRV Total Return Price data by YCharts What happened to SRV? As with some other high-profile CEFs profiled recently, what transpired with SRV in early 2015 was a distribution cut that triggered a massive collapse in premium/discount value. As can be seen from the chart below (source: CEFConnect ), SRV slashed its quarterly distribution by 68%, from $0.2250 to $0.0730 in 2015. Amusingly, after paying one quarter of its reduced distribution, SRV cut its distribution again by 26%, while simultaneously changing to a monthly distribution policy (perhaps to make the second distribution cut less obvious!). Taken together, the overall change from a distribution of $0.2250/quarter to $0.0180/month represented a 84% reduction for SRV holders. (click to enlarge) The distribution cut was accompanied by a massive reduction in premium/discount value, from some +30% to -10%, as can be seen from the chart below. This explains the severe underperformance of SRV vs. TYG and AMLP since Dec. 2014. (click to enlarge) Obviously, hindsight is always 20/20. But I believe that there were some warning signs that SRV investors could have heeded before the disastrous event. Lesson #1: Consider historical performance While historical performance is no guarantee of future results, the past return of a CEF can give an indication of the management’s competency in running the fund. The 3-year total return to Dec. 2014 (the hypothetical start date of this exercise) shows that even before the distribution cut had occurred, SRV had been severely underperforming TYG and AMLP on a total return basis. SRV Total Return Price data by YCharts On a price-only basis, the underperformance of SRV becomes even more visually striking. SRV data by YCharts The above charts indicate that the high distribution paid out by SRV has prevented it from growing its NAV, despite the bull market in MLPs. Even when total returns are considered, SRV still lagged TYG and AMLP in the three years to Dec. 2014. Lesson #2: Premium/discount matters! As investors in the Pioneer High Income Trust (NYSE: PHT ) (see here for my previous article warning of PHT’s expanding premium) and more recently, the PIMCO High Income Fund (NYSE: PHK ), have found out , a high starting premium simply increases the amount that a fund can fall when adversity strikes. On Dec. 22nd, 2014, SRV’s premium/discount had stretched to a massive +28.4%. In comparison, TYG’s premium/discount was -6.1% at the time. The following chart shows the 3-year premium/discount profiles for SRV and TYG. (click to enlarge) The chart above shows that in the two years leading to Dec. 2014, SRV’s premium/discount expanded from around +15% to over +30%. On the other hand, TYG’s premium/discount declined from +15% to around -10% over the same time period. Does it make any sense to you that the perennial underperformer SRV was immune to the MLP sell-off that began in the summer of 2014, while the benchmark-beating TYG was not? No, it doesn’t make any sense to me either. In fact, SRV’s premium continued to expand even while the oil crash was already well underway. My only explanation for this was that retail investors were enamored with SRV’s high yield and pushed up its market price relative to its NAV. CEF expert and Seeking Alpha contributor Douglas Albo frequently laments the “Insanity of CEF Investors.” I believe that this example qualifies. Lesson #3: Beware of yields that seem too good to be true On Dec. 22, 2014, SRV yielded 14.02% with a premium/discount of +28.4%, meaning that its yield on NAV was even greater, at 18.00% (!). Meanwhile, TYG yielded 5.43% with a premium/discount of -6.1%, giving a NAV yield of 5.10%. Given that both funds employ similar leverage (around 30%), and are investing in essentially the same universe, how can SRV be yielding more than three times on its NAV compared to TYG? It just doesn’t make any sense. Simply put, SRV’s yield was way too good to be true. Summary I believe that there were several warnings signs that could have allowed investors to avoid SRV before the calamitous distribution cut in early 2015. These were [i] a poor historical performance, [ii] a rising premium (while other and better funds in the same category witnessed premium contraction), [iii] a yield that seemed way too good to be true. My main regret is not being able to identify this short opportunity for readers, and/or warn existing holders to exit the fund beforehand. Nevertheless, I hope that this article will help investors pick out similar warning signs in their existing or potential CEF investments to allow them to take action earlier. 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.