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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. Scalper1 News
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