XLU - UTF: Buy This Fund And 1 Other Fund For Reliable Income

2024-01-14 09:00:00 ET

Summary

• Cohen & Steers Infrastructure Fund is a closed-end fund that invests primarily in securities of companies in the infrastructure space.
• For nearly 20 years since its inception, the UTF CEF has offered nearly 9% of annualized total returns and is currently paying 8.35% in distribution income.
• We believe UTF is an excellent fund for income investors; we would rate the fund as a selective "buy" for new investors. For existing investors, it is a "Hold." It may be preferable to dollar-cost-average the buy instead of a lump sum.

Introduction:

Cohen & Steers Infrastructure Fund ( UTF ) is a closed-end fund, or CEF, incepted in March 2004. The fund invests primarily in companies that provide either the basic infrastructure or services in the infrastructure industries. Under normal conditions, the fund aims to invest at least 80% of its assets in companies such as utilities, toll-road, railroads, ports, telecommunications, oil and gas pipelines, and any other company providing basic utility services. The fund is heavily weighted in the Utility sector.

As per the fund's literature :

" The Fund's investment objective is total return with an emphasis on income through investment in securities issued by Infrastructure companies. Infrastructure companies typically provide the physical framework that society requires to function on a daily basis and are defined as utilities, pipelines, toll roads, airports, railroads, marine ports, telecommunications companies, and other infrastructure companies. "

Other salient features of this fund are as follows:

• Focused on basic infrastructure companies in the areas of electric, gas, and water utilities, airports, railroads, toll roads, marine ports, telecommunications, etc.
• The fund uses roughly 30% leverage to enhance the potential for generating income. The fund utilizes interest rate swaps to reduce its exposure to variable rates in a rising interest rate environment. As of Jun. 30, 2023, the variable rate leverage accounted for roughly 15%, while the rest was fixed rate.
• The fund's use of leverage can increase the total returns in a rising market but can also have the opposite effect in a declining market. Leverage can make a fund more volatile than it would be otherwise.
• The fund employs a managed distribution policy under which it distributes $0.155 per share every month ($1.86 annually). It has paid the same amount since 2018. Right now, the fund is not earning enough in the form of NII (net investment income) plus the realized capital gains. If the fund does not earn enough in NII and Capital gains, the rest has to come from ROC (return of capital). However, UTF's record is not all that bad. In 2023, it paid 23% of the total distribution as ROC, while in 2022, it was only 3.55%.
• The fund invests globally, but the U.S. and Canada account for nearly 67% of the assets. The other countries where it has more than 5% of investments are Australia and the U.K.
• It is a highly diversified fund and has a total of 235 holdings (as of Sep. 30, 2023). The top 10 holdings accounted for nearly 30% of the total assets.
• As of Sep. 30, 2023, the fund had roughly $2.9 billion worth of assets under its management.
• The fund is an actively managed fund and has an expense ratio of 1.59% on the managed assets (total assets including leverage) and 2.19% on the basis of common assets (net assets attributable to shareholders). This includes 0.85% of management fees on managed assets (1.22% on net assets). However, based on the last semi-annual report, the total expense ratio works out to be 2.64% (on managed assets), out of which 1.68% was due to interest expense alone.
• As of Jan. 9, 2024, its distribution yield on the market price was 8.35% and 8.08% on the NAV.
• As of Jan. 9, 2024, UTF's market price offered a discount of -3.17% to its NAV., which is nearly the same as the 6-month average discount/premium of -3.02%. However, it is a lot more attractive than its 3-year average, which is a small premium of 1.02%.

Is the fund a better investment than a Utility or Infrastructure-based ETF?

So, why invest in a fund like UTF, with its high fees, when you can buy equivalent exchange-traded funds, or ETFs, at lower fees? Well, we think there are two reasons: UTF is a great fund for income seekers with its consistent, monthly, and relatively reliable high-income and matching (if not better) total returns. From Jan. 2005 until Jan. 09, 2024, UTF has delivered an annualized return of 9.20%, compared to 8.20% from Utilities Select Sector SPDR ETF ( XLU ) and 9.44% from the S&P 500.

Further, UTF is especially attractive if you are withdrawing the income. For example, if we had invested $1 million in each of the four funds (UTF, UTG, XLU, and S&P500) on Jan. 1, 2005, and started withdrawing inflation-adjusted $40,000 (4% of initial capital) every year (from each portfolio), we would have the following balances as of Jan. 09, 2024:

UTG – Reaves Utility Income Fund ( UTG ).

Table-1:

Note: The calculations were done using Portfoliovisualizer.com . Past performance is no guarantee of future results. Also, the result would vary depending on which year you started the investment. S&P 500 has beaten most investments in the recent 5-10 year periods.

Here are some additional factors/ reasons that you should consider:

• Several Infra-related ETFs have come up during the last few years. Two examples are Global X U.S. Infrastructure Dev. ETF (PAVE), and SPDR S&P Global Infrastructure ETF (GII). PAVE was incepted in 2017 and pays only a 0.70% yield. GII was incepted in 2007 and currently pays a 3.71% yield. Though GII has a 15-year history, it has performed very poorly since its inception.
• There is really one ETF fund that we can compare going back to 20 years, which is Utilities Select Sector ETF (XLU). As apparent from the above table, the performances of both UTF and UTG have been superior to XLU over the last 20 years. Besides, XLU only pays a 3.33% yield.
• Besides, UTF is an attractive fund if you do not like the idea of selling shares (of an investment) to raise income, as it causes too much uncertainty and emotional stress.
• We also recommend UTG at the right price for long-term investment and some diversification in the Utility sector. It has a similar yield and comparable past performance as UTF.
• If income is more important to you than the growth of capital, then funds like UTF and UTG are attractive long-term investments.

Financial Outlook:

Let's look at the Fund's Financial health and performance. The most recent detailed report that is available to investors is the semi-annual report for the period of Jan. 2023 – Jun. 2023. The annual report as of Dec. 31, 2023, is already due but is not likely to be available for some time.

Net Investment Income:

The net investment income (or NII in short) is the net income that a fund earns from its investment in the form of dividends, distributions, and interests or derivatives like options, minus all of the fund's expenses, including management fees, operating expenses, commissions, and interest on leverage. For equity-based funds, especially in high-growth sectors like technology, the NII is not very relevant. However, for funds like UTF, it is much more relevant. The main reason is that infrastructure companies usually are slow-growing companies but pay much higher dividend yields.

Here is what it looks like in terms of NII, Distributions, and Net Assets at the beginning and end of the statement period.

(all amounts are in US $ (except Shares Outstanding) for the 6-month period; negative amounts are shown inside parentheses, per the Semi-annual report, six months ending Jun. 30, 2023, and the Annual report, 12-months ending Dec. 2022).

Table-2:

Data-source: UTF's Semi-annual and Annual reports.

Distributions:

UTF provides a monthly (managed) distribution of $0.155 per share, which comes out to be a yield of 8.35% at current prices and 8.08% on the NAV (as of 01/09/2024). It has paid the distributions all along since inception but has switched from monthly to quarterly and then back to monthly. The last time it raised the distribution amount was in February 2018. It cut the distribution amount in 2009 and changed the frequency to quarterly. It has also provided special distributions in some years, especially in 2007 when it paid a large amount. During the past eight years, it has been more consistent and has done a better job of managing the distribution policy and making the distributions sustainable.

So, is the distribution covered?

This is a utility and infrastructure-focused fund. Even though the fund states earning total returns as its major objective, most investors invest in the fund for stable income. It employs nearly 30% leverage as well to enhance the income. Let's look at the most recent semi-annual report that we have available, ending on Jun. 30, 2023. We can see from Table-2 that the fund generated roughly $0.69 per share in total investment income (for a six-month period) but spent nearly $0.44 on the fund's expenses, leaving only $0.25 per share for the distributions. So, the rest of the distribution must come from capital gains, which can vary greatly depending on the market conditions. That's where the expertise of fund managers comes into play. We know that the last two years (2022 and 2023) have been pretty difficult for funds like UTF.

We can observe that for the first six months, it also got $0.223 from realized capital gains and $0.098 from the issuance of shares (mostly reinvestment). Though the issuance of shares is not really income, this cash was still available to the fund. So, that makes up $0.571 per share. However, the fund pays $0.93 per share for a six-month period. So, it is quite clear that it covered only about 61.5% of the distributions. So, the rest should come from ROC (return of capital).

However, on a full-year basis for the year 2023, if we look at the distribution records from the fund's website and do some math, it has reported paying only 23% ROC for 2023 (and only 3.55% ROC for the year 2022). That's not bad at all. Since its inception, the fund has gone through many market conditions, including the financial crisis, the 2015-2016 energy crash, the 2020 pandemic, the ongoing high-rate interest environment, and other smaller upheavals. We can only judge the management from its past record; it appears they have done a reasonably decent job so far.

Discount/Premium:

The fund is currently trading at a discount of -3.17% (to its NAV). But if you look at its 3-year history, it has traded at a small average premium of +1.02%. So, in that sense, it is a better deal from this metric. However, we should always look at both the premium/discount and the overall valuation of the fund and the sector. Generally speaking, the high-interest regime hit the valuations of all income-generating securities, including utilities and infrastructure companies.

Chart-1:

Funds Holdings:

The fund is fairly diverse and had 235 positions/securities as of Nov. 30, 2023. As we already know, the fund is invested globally in various infrastructure-related companies; however, the electric utilities take the biggest share, over 35%. The top 10 holdings of the fund make up about 30%, a significant portion but not over the top. Some of its largest holdings are NextEra ( NEE ), American Tower ( AMT ), Southern Co ( SO ), Transurban ( TRAUF ), TC Energy ( TRP ), National Grid ( NGG ), PPL Corp ( PPL ), CenterPoint Energy ( CNP ), Enbridge ( ENB ), and Dominion ( D ), among others.

Table-3:

Chart-2:

Performance:

If you are looking for high growth and total returns, you are looking at the wrong fund and sector. The utility and infrastructure sector is not the place to be in. However, it is very appealing for income investors for reliable and sustainable income. To income investors, we will suggest both UTF and UTG to invest in for more diversification and stable income. The historical performances of both UTF and UTG are similar, although their investment profiles are not exactly similar.

All that said, the long-term performance of UTF has been pretty impressive. Let's see how it compares over the last 20 years with UTG, Utilities SPDR Fund ETF ( XLU ), and the S&P 500. There are several infrastructure ETFs available, but most of them have been introduced in the last five years, so do not make a good comparison.

Table 4: (Data as of Jan. 09, 2024; data marked ** is for the period from Jan. 2005 to Jan.09, 2024)

Note: Some of the data (e.g., number of holdings and leverage) may not be current as of Jan. 09. 2024.

Risk Factors:

Investors need to be aware of certain risk factors that are associated with this fund and CEFs in general. UTF's near to mid-term future performance will be somewhat tied to the movement of interest rates. However, as of now, all indicators and expectations are pointing to interest rates going down in 2024, so we can expect some tailwind for the type of securities that UTF invests in. Further, lower interest rates should result in a lower interest burden for the fund.

Risk factors could be summarized as follows:

• The macroeconomic conditions and the movement of interest rates in 2024. If high-interest rates somehow stay higher than expected and there is at least some possibility, then that will be a strong headwind for this fund.
• The geopolitical situation.
• The occurrence of a recession in 2024, however, is expected to be a shallow one by most estimates.
• If the downcycle in utilities and infrastructure companies persists for a very long time, that may result in forcing the fund to pay the distributions by means of destructive ROC (return of capital). Currently, it appears to be an unlikely scenario.

Concluding Thoughts:

If you are a retiree or less than five years away from retirement, and you need your capital to earn you at least 5-6% income yield, then funds like UTF and UTG are for you. Though these funds are paying over 8% yield, we recommend reinvesting at least 2-3% back into the fund.

So, is it the right time to buy funds like UTF and UTG? We know that all kinds of income securities have been hurt in the last two years due to the rising interest rate cycle. We also know that that trend is about to change now, sooner than later. The declining rates will help boost all sorts of income securities, including these two funds.

Even though, along with the broad market rally, UTF has had a substantial run since November 2023, it is not as cheap as it was in October 2023. However, it is not expensive either at current prices. It is currently offering a discount of -3.17% as well.

We rate UTF as a selective "buy: for new buyers. For existing owners, it is a "hold" at this time. However, if you are a new buyer, buying it in multiple lots may be preferable, giving you the benefit of dollar-cost-average.

We believe income investors should hold both UTF and UTG for reliable income and diversification. We think that with interest rates declining from here, though there is no certainty, the utility and infrastructure sector will generally perform better.

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