BUI - Sustainable Power & Infrastructure Split Corp: Bag This 10% Yield As It Dips

Summary

• Sustainable Power & Infrastructure Split Corp. is a sector-specific investment product with a defensive focus.
• Its performance is only marginally lower than the SPY (S&P500) since PWI:CA's inception when including distributions, but lags other infrastructure funds, particularly ETFs, and volatility is greater than comparable funds.
• At the same time, PWI:CA pays a compelling distribution yield of almost 10% and has the opportunity for leveraged capital gains because of the structure.

This article examines the Sustainable Power & Infrastructure Split Corp. ( PWI:CA ), which may be a suitable option for investors looking for diversification in infrastructure and utilities with a compelling current distribution yield and opportunity to benefit from capital gains. The price has fallen by about 13% from the recent highs in August, following general market weakness. In this article, I focus on why it may be a smart time to look at this split share corporation and add it to your portfolio. I further examine some risks of the investment product structure and the volatility of the fund.

Why PWI:CA?

PWI:CA is a split share corporation, an investment product issued by Brompton Funds. It includes a basket of shares and other funds that are components of the actively managed, globally diversified, portfolio focusing on sustainable power and infrastructure. This, by its nature, gives investors the opportunity to benefit from the multi-decade shift in power generation and use as we seek to decarbonize our economics and enhance corporate sustainability. PWI:CA shareholders further benefit because the structure of the investment product provides a 'structural leverage' which we explain below.

First, we can examine the diversification benefits from the fund overview .

A quick look at the top 10 holdings (Figure 1) shows somewhat limited diversification, which is not unusual with the split share corporation structures holding fewer shares than many comparable ETFs. (Indeed, some split share corporations hold as few as a single stock!) The top holding is the Brompton Sustainable Real Assets Dividend ETF ( BREA:CA ), at about 5.4% of NAV, suggesting further diversification. However, a look at the composition (Figure 2) shows this adds little diversification benefit with the top 10 holdings constituting 50% of the ETF's NAV.

So, there is not as much diversification by company holdings as we see in many other ETFs.

For investors in the funds home of Canada, there is substantial exposure to non-domestic listings (Figure 3). Even for a US-based investor, the investments span the globe. For many investors, this global investment in infrastructure can be a welcome geographic diversification benefit.

Finally, the terms 'power' and 'infrastructure' can be used loosely, so it is interesting to get a sense of sector allocation (Figure 3). Not unsurprisingly, utilities come in with the biggest proportion of NAV. But there is a pleasing range of sectors represented in PWI:CA, including some Information Technology, Real Estate, and even a limited Consumer Discretionary sector allocation.

Overall, the level of diversification is a welcome addition to many portfolios.

Split share corporation structures

To help us understand how the split structure works and what it offers each class of shares, we will use a basic example. I have provided a more complete overview of some benefits and risks of the structure in a separate article .

The split share corporation has two classes of shares, each targeting distinct types of investors. Each type of investor essentially puts up 50% of the funding to purchase a portfolio of common shares for the split share corporation. Using simple proportions, we can then explore how the structure provides a form of leverage for Class A share investors. The unit NAV is the combined NAV for both Class A and Preferred shares

• The Class A shareholder contributes 50% of the funding but receives (for example) 100% of the portfolio's capital gains. Distributions for Class A shareholders are sourced from capital gains, excess dividends from the portfolio (not paid to the preferred shareholders), and possibly the sale of covered calls on the portfolio. If the underlying holdings perform well and grow their dividends, the portfolio can increase the net investment income to the benefit of its Class A shareholders.
• Preferred shareholders contribute the remaining 50% of the funding. Most dividends from the underlying shares are paid to Preferred shareholders as their distribution. They may receive, for example, about 100% of the portfolio dividend income (at inception) as their distributions. This is a high distribution yield on their 'share' of the split share corporation. Growth in the dividend payments to the split share corporation will benefit the Class A shareholders, who also receive all capital appreciation.

The $15 rule and distribution suspensions

The split share corporations have a mechanism in place that prevents the erosion of NAV. If we think about the structure, a decrease in the NAV and decreases in dividends paid to the split share corporation would result in losses for shareholders unless there was a 'safety mechanism' to prevent distributions during tough times.

The split share corporations have a "$15 rule" that seeks to prevent this NAV erosion. The Unit NAV comprises 1 Class A share and 1 Preferred share. If the Unit NAV drops below C$15, they make no distribution to Class A shares.

The suspension of distributions keeps capital in the fund and will slow the erosion of the NAV and allow the NAV to recover. The outcome is the NAV is protected so that the unit NAV can recover and exceed C$15 again. If this happens, distributions will resume. However, the unit NAV may not always rapidly recover to exceed C$15; Brompton Oil Split Corporation ( OSP:CA ) 2022 Interim Report (p. 2) notes the extended period the fund experienced with no distribution for OSP:CA Class A shareholders:

There were no distributions paid to Class A shareholders in the first six months of 2022 and 2021 as the Net Asset Value per unit (consisting of one Class A share and one Preferred share) was below the $15.00 threshold during the period.

This is a key risk and consideration with split share corporations - if the unit NAV erodes, there is no guarantee that it will exceed C$15 again and distributions to Class A shareholders will resume.

The current unit NAV is C$17.39 (August 31, 2022) with the Class A share price at C$8.25 compared to the NAV of C$7.31 (August 31, 2022).

Distributions and source of income

One of the major benefits that a split share corporation brings the Class A shareholders is a relatively high distribution yield and the opportunity to benefit from leveraged capital appreciation.

PWI has a TTM distribution yield of 9.7%. Each month, the Class A shareholders receive a C$0.06667 payment if the Unit NAV exceeds $15 (the "$15 rule"). This is a relatively new product with a history only from May 21, 2021. This limited history makes it difficult to assess the durability of the fund structure and whether it is likely to miss future distributions.

The source of income is also important to note. In 2021, there was a small use of Return of Capital to shareholders in the first three months of operation.

We draw the following insights from the interim 2022 results covering the first six months. The dividend income fully covered the Preferred distributions, as we would expect. The remaining dividend income did not cover the Class A distributions.

Brompton also generates income from options and the Interim 2022 results (p.1) note they use "[c]overed call options and cash?covered put options may be written in respect of the portfolio to generate additional distributable income for the Fund and/or to reduce the volatility of the Fund." Over the first six months of 2022, the average notional value was 3.9% of the Fund’s portfolio; on June 30, 2022, the notional value of options was 5.2% of the portfolio. They note (p. 11) how they "increased our call options overwrite levels to generate additional yields while providing a cushion against further market decline." By my calculations, their income from options was about 7% of the distributions to Class A shareholders. Even if they increase the average notional value of the fund they write options against, option income is unlikely to close the gap.

A final source of cash used to pay distribution is from the proceeds from the sale of investments. They are an actively managed fund, albeit with a low turnover. They noted the pivot to a more defensive stance in 2022, which would entail the sale of some assets and some proceeds would fund distributions. Over time, we might expect this to erode the NAV as they distributed rather than reinvested the proceeds.

While the planned increase in options income will cover an increased proportion of Class A distributions in 2022, dividends and options will not fully cover the Class A distributions in the fund. This is a risk to consider.

Peer comparison - a focus on returns and volatility

Making a comparison with some peers to assess returns and volatility is difficult as there are few sustainability- or ESG-focused funds to select from. As a result, I have included mostly infrastructural-focused funds and used several ETF and CEF funds as the CEF funds often use leverage and may be more comparable to the PWI:CA situation.

• Brompton Sustainable Real Assets Dividend ETF ( BREA:CA )
• BMO Global Infrastructure Index ETF ( ZGI:CA )
• FQF Trust - AGFiQ Global Infrastructure ETF ( GLIF )
• iShares Global Infrastructure ETF ( IGF )
• Macquarie Global Infrastructure Total Return Fund ( MGU )
• BlackRock Utility&Infrastructure Trust ( BUI )
• Voya Infrastructure, Industrials and Materials Fund ( IDE )
• Cohen&Steers Infrastructure Fund ( UTF )

To make a comparison, I've used PWI:CA's inception date to give as much history as possible (Figure 5). Due to the strong distribution yield of this fund and other CEFs in the comparison, both price and total returns seem relevant and are displayed on separate panels.

Figure 5. PWI:CA compared with ETF and CEF peers showing both total return and price returns since PWI:CA's inception

What can we learn from these figures? Part of the underperformance shown in Figure 5 is likely because of the structural leverage of PWI:CA's split share corporation investment product.

While this should be a risk-off environment that is favorable to these types of infrastructural and utility funds, Figure 5 shows that the CEFs are underperforming the ETFs, likely because of the additional leverage they frequently employ, exacerbating the downward market pressures.

As a final comparison to understand the performance, Figure 6 summarizes how PWI:CA compares to SPY. In terms of price changes, we see PWI:CA is down 15% over this period compared to SPY's decline of 4.5%. However, the high distribution yield that PWI:CA investors receive relative to the SPY boosts the total return, making a more favorable comparison on the bottom panel of Figure 6 showing the total returns of -4.45% and -3.08%, respectively. These overall returns in a difficult market environment are a reason I am bullish on PWI:CA; when conditions are more favorable, I expect the investment to provide strong capital gains due to the leveraged nature of the product.

Figure 6. PWI compared with SPY with total return and price returns since PWI's inception

Is PWI right for your portfolio?

I cannot answer this question, but here are some questions I ask myself when looking at a new fund. While I am very positive about PWI's prospects and fit with my portfolio and needs, it will not be right for every investor. Consider these questions to identify whether it is right for you.

1. Am I overpaying for this fund? Is it trading at a premium?
   • Brompton lists this trading at a premium, with the price of C$8.25 compared to the NAV C$7.31 (August 31, 2022). CEFs may trade at a discount or premium. All the Brompton Split Share Corporations trade at a premium. By way of comparison, a popular income CEF is Liberty All-Star Equity ( USA ), focusing on U.S. equity investments. It has traded for a short time at double-digit premiums over the last year, and is currently at a 3.15% premium.
2. Can I get caught out by the $15 rule?
   • Brompton lists this trading at a unit NAV of C$17.39 (August 31, 2022).
   • While this is over C$15, it does not need to fall far for the distributions to be suspended. As noted earlier, the proceeds from the sale of investments that are not reinvested partly funded the distributions, which will erode the NAV.
   • Investors will need to consider their individual circumstances and what a distribution suspension may mean for them.
3. How does this fund complement my wider portfolio?
   • The fund has limited diversification, but some good global diversification for many investors that otherwise might hold individual utility, infrastructure, or material companies in their portfolio.
4. Does this fit my objectives for growth or income?
   • If reliable income is important - for retirees or others needing the security of income, keep in mind that distributions will be entirely suspended if the NAV drops too far.
   • When looking for long-term growth, the target of the fund is one that I have confidence in with a long-term horizon. The fund structure should enable out-performance because of the structural leverage, but this may entail holding the investment through sizeable drawdowns because of the relatively high volatility.
5. Do I want to manage international holdings?
   • Some investors have brokerages that do not allow them to buy the Canadian-listed PWI:CA.
   • If you are not Canadian but want to invest in it, you will deal with currency fluctuations and international taxation. This may be more of a headache than many investors desire.

Investors' takeaway

The Sustainable Power & Infrastructure Split Corporation gives investors access to a portfolio of sustainable utility and infrastructure companies with good global diversification and a high distribution yield. The valuation holds up well against comparable peers, but there is limited history to draw on.

Looking ahead, I expect the distribution coverage to expand with the increase in options writing. With the 10% distribution yield, there is a lot to like here for income lovers. The structure provides either the same consistent payout every month or a complete distribution suspension.

As a consequence, I believe PWI:CA offers a good option for income and may provide valuable diversification to many portfolios while offering long-term growth prospects. Expect it to underperform in times of market downturns and experience more volatility than we might expect from utilities or infrastructure. The current dip provides a good opportunity to grab some shares of PWI:CA and ride the sustainability wave of the future.

Investors interested in the sustainability theme and infrastructure might consider other options, such as the Brompton Sustainable Real Assets Dividend ETF ( BREA:CA ), which may provide less volatile returns and lower distributions, but more stability and no structural leverage.

The opportunity to invest in sustainability-oriented utilities and power, the diversification, and strong income and capital gains potential, are key reasons I am adding this to my portfolio this week.

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