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ERH: A Mix Of Bland And Spicy, But How’s The Taste?

Wells Fargo Advantage Utilities & High Income Fund isn’t a pure utilities fund. What it does provide is an interesting mix of “high” risk and “low” risk assets. Overall, though, I’m not impressed, but it might make sense for those playing premiums and discounts. I recently wrote a couple of articles about infrastructure closed-end funds, or CEFs. One of the comments asked about my thoughts on the Wells Fargo Advantage Utilities & High Income Fund (NYSEMKT: ERH ). My take: It’s an interesting fund, but it’s not easy to pin point what kind of fund it is or provide a good reason for owning it. Not an infrastructure fund As soon as you take a look at the portfolio of ERH you see that it is not an infrastructure fund. Sure, it owns infrastructure assets, primarily in the utility space (though it also owns some pipelines). But it isn’t as broadly diversified as the Reaves Utility Income Fund (NYSEMKT: UTG ), the Cohen & Steers Infrastructure Fund (NYSE: UTF ), or the BlackRock Utility and Infrastructure Trust (NYSE: BUI ). All of which venture well beyond the utility sector, including such things as toll roads. ( I compare UTG and UTF here , and I examine BUI here .) So, if you are looking for broad infrastructure exposure, you’d be better off with a different fund. But, interestingly, this is not the defining difference between ERH and these other funds. The defining difference is that ERH combines utilities with preferred stock and high yield debt. At the end of February , the portfolio breakdown was roughly 60% stocks (mostly utilities), 30% high yield bonds, and 10% preferreds. So about 40% of the fund was invested in fixed income, or at least fixed-income like, assets. Moreover, the 30% in bonds was focused around high-yield bonds, which many would consider living on the complete opposite side of the risk spectrum from utility stocks. But that’s where this fund becomes interesting. It isn’t alone in pairing up different asset classes. For example, the Cohen & Steers REIT and Preferred Income Fund (NYSE: RNP ) is another fund that combines disparate income-focused assets under one roof. A yield kick? For ERH, the benefit of putting utilities, high-yield bonds, and preferred stock together is to create a portfolio that spits out plenty of income. On that front, the fund’s yield of nearly 8% is above UTG and UTF, but about on par with BUI. BUI makes use of options, which helps enhance distributions. ERH does not use options, but does use leverage (about 22% of assets at the end of the first quarter), like UTG and UTF. So it appears that adding high-yield debt to the picture allows ERH to add income over roughly similar funds that focus more on equity investing. That said, it is worth noting that ERH cut its distribution in 2011. Return of capital made up a little over half of the fund’s distribution the previous year, so that 2011 call was likely a good one. In fact, since that time, the fund’s net asset value, or NAV, has grown from $11.20 or so a share to around $12.70. All the while it’s spit out a steady $0.90 a share in distributions each year with none coming from return of capital. An odd ball While it’s hard to complain about that, the fund is an odd mixture of risks. For example, when it comes to bonds, high-yield is among the most aggressive options out there. But, interestingly, even high-yield bonds are lower risk than stocks, using most broad benchmarks. But in stocks, utilities are usually considered low risk. So there’s this interesting low risk/high risk mash up going on. ERH’s trailing five year performance through May provides a good example of what can happen when things go well. Over that span, ERH’s standard deviation was roughly 9.3. The Vanguard High Yield Corporate Fund’s (MUTF: VWEHX ) standard deviation was lower, at 5.4, while the Vanguard Utility Index Fund’s (MUTF: VUIAX ) was higher, at 11.4. Trailing annualized performance, which includes the reinvestment of distributions, meanwhile, fell along the risk lines. VWEHX had a trailing five year return of 8.8%, ERH posted an annualized 12% or so, and VUIAX came in at 13.8%. For comparison, SPDR S&P 500 Index ETF turned in a trailing return of 16.4% with a standard deviation of roughly 12.3. Essentially, the mix of assets in ERH reduced volatility and enhanced return relative to investing in stocks alone. The trailing three year numbers are roughly similar, but the trailing 10-year results are a stumbling block. ERH’s standard deviation was higher and return lower than both VWEHX and VUIAX over that span. So the fund doesn’t always live up to what you might expect. Unique and not right for most I could keep going, but there’s enough here to show that ERH is really an odd duck. It isn’t an infrastructure fund, it isn’t a utility fund, it isn’t a high-yield bond fund, and it isn’t a preferred fund. It’s a little bit of each. And while the idea of mixing different asset types makes logical sense, it hasn’t always work out the way an investor might hope here. While recent performance has been solid, longer-term results have been mixed, at best. Moreover, I’m not sure that ERH would play nicely with your portfolio if you use an asset allocation model. Yes, it could be used to shift allocations on the edges, but I’m not sure utilities, preferred stock, and high-yield are the places you should be looking for flexibility. For most investors seeking utility or infrastructure exposure, I’d suggest going with a fund that is really focused in those spaces. For investors seeking income, I think there are probably better ways to go about finding it. Unless you are looking specifically for a high-yield and utility fund for some reason, I’d suggest passing on this one. That said, if you like to play premiums and discounts, ERH is currently trading hands at a nearly 10% discount to its NAV. It’s trailing three-year discount is around 4%. With such a wide break from historical averages, now could be a good time to try to take advantage of this disparity. Other than that, I can’t come up with a great reason to own this fund. Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

BlackRock Utility And Infrastructure Trust: An Option Player In The ETF Utility Space

I recently looked at UTG and UTF, leading readers to ask about BUI. BUI is BlackRock’s entrant into the infrastructure space. The biggest difference it offers is the use of options. I recently wrote an article reviewing two relatively long-standing infrastructure closed-end funds , or CEFs. My conclusion being that Reaves Utility Income Fund (NYSEMKT: UTG ) and Cohen & Steers Infrastructure Fund (NYSE: UTF ) are both good products, though UTF is trading at a wider discount at the moment. Readers of that article asked my take on BlackRock Utility and Infrastructure Trust (NYSE: BUI ), another option (that’s a pun, actually) in the space. What is BUI? BUI opened its doors in late 2011, meaning that it doesn’t have the longevity of UTG or UTF. In fact, it hasn’t really witnessed a major market correction yet, like the pain we all suffered at the turn of the century and more recently during the 2007 to 2009 recession. This is less of a knock than a piece of information to keep in mind. BUI isn’t doing anything outlandish, so it’s unlikely it would “blow up” in a downturn. Actually, just the opposite is likely to be the case, but that expectation is untested. That said, what does it do? As the name implies, like UTG and UTF, BUI invests in things like electric utilities, water utilities, pipelines, bridges, and other similar hard assets. These are the types of things we take for granted, but without which life simply wouldn’t go on as it had before. On that score, it does, indeed, deserve to be looked at with UTG and UTF. However, there’s a not too subtle difference here. UTG and UTF both make use of leverage. BUI does not. It enhances returns, specifically income, through the use of an option overlay strategy . This means two things: return of capital will always be an issue and the options it writes could provide downside protection in a bear market. One of UTG’s big bragging rights is that it has never used return of capital to support its distributions. They have always come out of income and capital gains. You can argue this doesn’t matter much so long as a fund isn’t using destructive return of capital over extended periods. For example, UTF has used return of capital in the past and in one recent year it was destructive (the net asset value went down at the same time as return of capital was being used to support the dividend). However, that was one year and UTF hasn’t used return of capital recently. But some investors are highly suspicious of return of capital distributions. And BUI has made use of return of capital every single year. Why? Because it writes options. Dividends and interest on debt fall into investment income. Capital gains fall into, well, capital gains. Option income isn’t either of those things and winds up getting shoved into return of capital. It hasn’t proven to be a bad thing at BUI, with the net asset value, or NAV, increasing from $19.10 a share at its initial public offering to $21.50 or so more recently. So, at this point, the issue of return of capital hasn’t been a big one and likely only matters if you have a personal issue with that type of distribution. Looking at options from a different angle, the premiums received can provide return during down markets. This protects an option writing fund’s returns to some extent from the full effects of a market decline. In the case of BUI, however, that’s more of an academic issue because the fund has yet to deal with a truly severe downdraft. So, in theory, BUI should hold up better than UTG or UTF in a downturn. But it’s worth noting that the use of leverage at these two funds is likely to result in notable underperformance during a bear market. Both funds, for example, lost more than 40% of their NAV value in 2008. A fact to keep in mind when you consider that options can also limit BUI’s upside because positions will get called away. So BUI should lag in good markets and shine in bad ones compared to UTG and UTF. How has it done? Looking at performance numbers, BUI has underperformed relative to UTG and UTF on an NAV total return basis over the trailing three-year period through May (BUI’s short history means that’s the furthest back this trio can be compared). Interestingly, however, over the trailing six months period, UTG is down 2.7%, UTF is up a scant 0.4%, and BUI is up roughly 1.8%. Although hardly a bear market, while UTG and UTF have struggled, BUI is beating them. BUI’s standard deviation goes right along with that. UTG and UTF have three year standard deviations, a measure of volatility, of 13.5 and 11.4, respectively. BUI’s standard deviation is a far more subdued 8.5% over that span. Looking at cost, UTG is trading at a small discount to its NAV and roughly in line with its historical price trends. UTF, meanwhile, is trading far more cheaply at an around 14% discount. BUI is trading at a discount of around 12%, nearly three percentage points more than its trailing three-year average discount. Investors looking for bargains should be interested in UTF and BUI. That said, if you are concerned about risk, BUI should have the edge (despite the fact that it hasn’t been stress tested by a deep downturn). Yield wise, BUI’s distribution is around 7.5%. That’s in the same area as UTF, but notably above UTG’s 6.3% yield. That said, it’s worth repeating that UTF and UTG use leverage to enhance yield, hopefully earning more in dividends than they pay in interest. BUI, on the other hand, generates income by selling options on its holdings, which generates return of capital, can limit upside potential, yet also helps to reduce volatility. And options are also cheaper to deal with, which is why BUI’s expense ratio is around 1.1%. Both UTG and UTF have to contend with interest costs, which push their expense ratios up to 1.7% and 2.2%, respectively. Who’s BUI for? Whether or not you want to purchase BUI really boils down to your concern about market volatility. If you think the markets are trading at premium levels and could be due for a correction, theoretically, BUI is probably the best choice out of these three funds. It also has the allure of trading at a noticeable discount, like UTF, if you prefer to buy on the cheap. And it’s the least expensive to own based on fees. All of that said, I still like UTG because of its longevity and the fact that it has never cut its distribution. But for risk-averse investors who don’t have an issue with return of capital, BUI is truly worthy of consideration. Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.