TRAUF - UTF: Utilities Spiral Creating Long-Term Opportunity

2023-10-12 05:58:52 ET

Summary

• Cohen & Steers Infrastructure Fund has a solid track record but has recently taken a sharp turn lower due to its exposure to utilities.
• The fund's largest position, NextEra Energy, has seen a massive move lower, impacting the performance of the fund.
• Despite the drop in UTF, its discount to net asset value per share has not significantly widened, but the drop is still presenting a potential opportunity for investors.

Written by Nick Ackerman, co-produced by Stanford Chemist.

Cohen & Steers Infrastructure Fund (UTF) is one of the better long-term infrastructure funds to choose from in the closed-end fund space. They have a solid track record of delivering results. However, they more recently have taken a sharp turn lower, and this is primarily led by its utility exposure taking a massive hit.

In particular, the fund's largest position, NextEra Energy (NEE), has seen a massive move lower. Utilities have been under pressure due to rising interest rates, but this sped up when NEE sent out softer guidance than expected for its yieldco, NextEra Energy Partners (NEP). NEE is the largest position by a wide margin in the Utilities Select Sector SPDR ETF (XLU), meaning that, in general, it has an outsized impact on the sector performance itself.

Just as they did that recently, the 10-year risk-free Treasury rate shot up to new highs not seen since 2007. While I hold a position in NEE and several other utility names that are getting slammed, a more conservative approach could be taking advantage of this downturn with the more diversified pool of names that UTF can offer to investors.

Despite this sizeable drop for UTF, it should be noted that the fund's discount to net asset value per share has not actually widened significantly. Still, the drop overall is tempting to take advantage of nonetheless.

The Basics

• 1-Year Z-score: -0.44
• Discount: -2.43%
• Distribution Yield: 9.64%
• Expense Ratio: 1.36%
• Leverage: 31%
• Managed Assets: $3.06 billion
• Structure: Perpetual

UTF's objective is

"total return, with an emphasis on income through investment in securities issued by infrastructure companies." They define infrastructure companies as those that; "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 and telecommunications companies."

They aren't limited to where they can invest globally or in what part of a company's capital stack. That gives them both geographic exposure and asset class flexibility to invest where they see fit.

The fund does utilize leverage, and while some funds are experiencing a headwind in that department due to rising costs, UTF has largely hedged most of its leverage through interest rate swaps. So, while the fund's total expense ratio has exploded from 2.44% to 3.72%, they've been making some of that up on the capital gains side of their portfolio.

The average term of the fixed-rate financing is for another 3 years. That gives them some time to wait for rates to come down before feeling the full force of the drag of higher borrowing costs.

Discount Remains Narrow, But Plunge Could Provide Opportunity Anyway

Generally speaking, we often see that discounts widen during times of panic for funds. In fact, we just recently touched on how discounts are at some of their most historically wide, more broadly for the CEF space.

That being said, UTF has hung on to a narrow discount despite this much greater volatility in its investing sphere. That has left it to still trade above its longer-term average discount that the fund has historically traded at.

In fact, since our last update, the fund has seen its discount narrow just a touch. That would be despite seeing quite a sharp drop that came primarily in the last couple of weeks.

In this case, the sheer drop in valuations of their underlying holdings is what I believe could be presenting an attractive long-term entry-level despite the fund itself not sporting the most enticing discount.

Distribution Should Be Watched

Now, the bad news for the fund is that with this significant drop, the fund's distribution isn't looking as healthy as it once was. As a mostly equity fund, they will rely significantly on capital gains to cover the payout to investors. Therefore, a plunge in the utility space will make this more and more difficult as time goes on.

As of their last report, net investment income coverage came to 27%, which was quite similar to what coverage looked like in the prior year.

Utilities could remain under pressure with rising interest rates and keeping the fund from achieving sufficient capital gains. That could tarnish its fairly solid record of only having to cut its distribution in the global financial crisis.

While no one likes distribution cuts, given the environment and the NAV distribution rate heading to 9.4% more recently, this is something to consider. That being said, a distribution cut does not automatically mean poor results going forward. In the short-term, the discount would likely widen out, but it could provide a chance to merely average down for longer-term investors.

This also isn't a risk just for UTF but most of the utility equity funds - and equity funds, in general, as equities start to weaken more broadly.

We had discussed the tax classifications for the fund earlier this year; here is a recap:

The distribution tax classifications largely reflect what we see above. Most of the fund's distribution was considered long-term capital gains. However, even better for investors holding in a taxable account, the portion classified as dividends have all been qualified in the year 2022 .

UTF's Portfolio

The fund's portfolio is heavily invested in equity positions, with 84% of the fund tilted to that asset class. The fund also takes advantage of the exposure that it can hold outside of the U.S. The U.S. allocation is the largest of the pie, but a meaningful amount is also invested in Canada, Australia and the U.K.

The largest subsector of infrastructure the fund invests in is electric utilities by a fairly wide margin. This is then followed by their corporate bond exposure, which they classify on its own. The fund then invests in some midstream companies as well as toll roads and freight rails. Finally, the fund also carries some gas distribution utility exposure, which hasn't offered really any relief as the whole utility space was dragged lower from NEE and rates.

Speaking of the main culprit, NEE, at least as of the end of June 30, 2023 , was UTF's largest position by a fairly meaningful amount. It carried over a 5% weight, with the next largest holding coming in as Transurban Group (TRAUF) at a 4% allocation. The fund is diversified in terms of geography and industry allocation, but the top ten still represent a fairly healthy chunk of the fund at around a third of total invested assets.

Here is a look at the performance of the top five holdings alone in the last month. This is a good representation of the overall fund and just how challenged these securities have been as rates are rising. Of course, NEE is really the outlier here and the main culprit, as mentioned, for driving the results of UTF significantly lower.

Conclusion

Utilities are getting whacked by interest rates rising and offering tempting risk-free yields. In addition to that, higher interest rates also slow growth going forward for the sector - as NEE recently admitted in a dramatic way. That being said, for long-term investors, it can set up an opportunity to take advantage of these lower valuations.

By investing in the sector via a diversified fund, you aren't making a bet that an individual company will perform but that the sector itself will survive another day. This is a more conservative approach, in general. Though the leverage the fund utilizes should also be considered as that does increase both the upside but also the downside potential of the fund as well.

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