2023-11-30 09:52:50 ET
Summary
- The Kayne Anderson Energy Infrastructure Fund specializes in investing in midstream corporations, master limited partnerships, utilities, and renewable energy.
- The KYN closed-end fund's yield of 10.08% is higher than most equity closed-end funds and is appealing to income-seeking investors.
- The fund's focus on midstream companies provides stability and potential for future cash flow growth, making it an attractive option for investors concerned about the near-term outlook of the American economy.
- The fund's distribution appears to be sustainable at the current level.
- The fund is currently trading at an enormous discount on net asset value.
The Kayne Anderson Energy Infrastructure Fund ( KYN ) is a closed-end fund, or CEF, that specializes in investing in midstream corporations, master limited partnerships, utilities, and renewable energy. There are several similar funds in the market, although with First Trust’s recent announcement that its four energy infrastructure funds will be merging into a single exchange-traded fund, or ETF, the number of closed-end funds investing in this sector is declining. This is perhaps something of a mixed blessing, since most energy infrastructure closed-end funds trade at enormous discounts to their intrinsic value, but theoretically should be able to outperform any exchange-traded fund due to their ability to use leverage.
Lately, many energy infrastructure funds have failed to live up to this potential though as the current 8.18% yield of the Alerian MLP Index ( AMLP ) is greater than that of many energy infrastructure closed-end funds. The Kayne Anderson Energy Infrastructure Fund is an exception to this, however, as this fund yields 10.08% as of the time of writing. That is better than most equity closed-end funds today and is certainly an appealing enough yield to get the attention of anyone who is seeking to generate income from their energy positions, which applies to many of those individuals who are looking to invest in midstream companies in the first place.
As regular readers will no doubt recall, we last discussed the Kayne Anderson Energy Infrastructure Fund on September 25, 2023. The fund’s performance since that time has, unfortunately, not been particularly impressive. The share price of the Alerian MLP ETF ( AMLP ) has gone up by 1.41% over the period, which completely dominates the 5.88% decline of the Kayne Anderson Energy Infrastructure Fund:
However, one of the defining characteristics of midstream companies is that they deliver a significant portion of their total return in the form of direct payments to their investors. We can see this quite simply in the fact that the share price of the Alerian MLP ETF has gone down by 49.85% over the past ten years but investors who held it for that entire period actually received a 14.96% gain:
As such, share price appreciation is not necessarily the most important thing when evaluating the performance of companies and funds in this sector. The most important thing is how well investors do after the distribution is considered. After all, a large enough distribution can offset a share price decline. In this case, investors who purchased shares of this fund on the date that we last discussed it have lost 3.55% of their investment compared to a 3.57% gain for those investors who purchased the Alerian MLP Index:
Unfortunately, this is a similar scenario to that of most energy infrastructure closed-end funds over the past few years. These funds have generally underperformed the Alerian MLP Index over time. There could still be some reasons to purchase this fund though, which we will discuss in this article.
About The Fund
According to the fund’s webpage , the Kayne Anderson Energy Infrastructure Fund has the primary objective of providing its investors with a very high level of total return. Specifically, the website states that the fund’s investment objective is:
To provide a high after-tax total return with an emphasis on making cash distributions to stockholders. KYN intends to achieve this objective by investing at least 80% of its total assets in securities of Energy Infrastructure Companies.
This description seemingly implies that the fund may invest in either debt or equity securities, as long as they are issued by an energy infrastructure company (defined as a midstream, natural gas or LNG infrastructure company, utility, or renewable energy company). However, as I pointed out in my previous article on this company, the fund’s current positions are entirely common stock. Unfortunately, CEF Connect’s asset allocation chart is still from November 2021, so it is very much out of date at this point. The chart at CEF Connect states that 142.08% of the fund’s net assets are invested in common stock.
The fund’s third-quarter 2023 financial statements , which correspond to the three-month period that ended on August 31, 2023, state that 138.8% of the fund’s net assets are invested in common stock. The fund does not hold any other long-term investments, although it does have call options written against a very small percentage of the portfolio. Thus, despite the description implying that the fund can invest in any securities issued by an energy infrastructure company, it appears that this fund is only investing in common stock.
As this is an equity closed-end fund, the fund’s focus on the provision of total return makes a great deal of sense. After all, common equity is by its very nature a total return vehicle since investors purchase it both to receive income and to benefit from capital gains as the issuing company grows and prospers over the passage of time. However, energy infrastructure companies typically deliver most of their returns in the form of direct payments to the shareholders rather than capital gains. One of the biggest reasons for this is that many of these companies do not exhibit particularly rapid growth. For example, let us take a look at Enterprise Products Partners ( EPD ), which is one of the largest companies in the midstream sector and the largest individual position in the fund. Here is that company’s net income during each of the past eleven twelve-month periods:
As we can see, the company’s net income went from $3.7675 billion to $5.3840 billion over a period of two and a half years. That is a 42.90% growth rate over the period, which is actually surprisingly more than Apple ( AAPL ) or Alphabet ( GOOG ) managed to grow over the same period. However, Zacks Investment Research expects that Enterprise Products Partners will see its net income decline this year compared to last year. In addition, the market tends not to bid up the unit prices of midstream entities, so these companies are not rewarded as much for growth as companies that we see in other sectors. They have responded by paying out distribution yields that are high enough to provide investors with a very attractive overall return even if the stock price delivers very limited appreciation. As such, these entities are sometimes purchased by investors who are seeking income as opposed to those who are after total returns or long-term capital appreciation.
The reason why this discussion thus far has focused on midstream companies as opposed to the other types of energy infrastructure companies that the Kayne Anderson Energy Infrastructure Fund can theoretically invest in is that the overwhelming majority of the fund’s holdings are midstream companies of various sorts. As already mentioned, the fund’s most recent financial report states that 138.8% of net assets are invested in common equities. This same report states that 121.8% of the fund’s holdings consist of midstream companies, which vastly exceeds any other sector. We can see that here:
Kayne Anderson
Clearly, the overwhelming majority of the fund’s assets are invested in midstream energy companies. In fact, this midstream energy weighting is so large that nothing else really matters that much. As such, anyone purchasing this fund should be aware that they are basically investing in the midstream sector and not in the renewable energy sector or the utility sector, which tends to have higher weightings in many other midstream funds.
The fact that this fund invests overwhelmingly in midstream companies is something that could be appealing to any of those investors who are concerned about the near-term outlook of the American economy. This is because midstream companies in general tend to enjoy remarkably stable cash flows due to the business model that they employ. I described this business model in my previous article on this fund:
In short, the company enters into long-term (typically five to ten years in length) contracts with its customers. Under the terms of these contracts, the midstream company moves a customer’s natural gas, natural gas liquids, and crude oil through its network of pipelines and other infrastructure. In exchange, the customer compensates the midstream company based on the volume of resources that are transported.
This tends to result in a midstream company having incredibly stable cash flows regardless of the direction of energy prices. That could be a positive thing right now, as crude oil prices usually decline whenever the economy enters into a recession. The market has lately been expecting that the Federal Reserve will cut rates by more than 100 basis points next year, and that pretty much means that investors are widely anticipating a recession. If that occurs, energy prices could drop temporarily but the nation’s midstream companies should see their cash flows relatively unaffected. This was the same thing that happened back in 2020, when energy prices fell sharply but most midstream companies saw their financial performances unaffected (although their common stock and partnership unit prices did decline).
As regular readers are no doubt well aware, I have devoted a considerable amount of time and effort to discussing various midstream, and other energy infrastructure companies, over the years. These articles have been published on the Seeking Alpha main site as well as here at Energy Profits in Dividends, so it is quite certain that any regular readers have seen them. As such, the majority of the fund’s largest positions will probably be familiar. Here they are:
Kayne Anderson
I have discussed all of these companies except for Western Midstream Partners ( WES ) several times over the past ten years. The majority of them are generally good companies in the sector that provide some diversity in terms of the products that they transport. For example, The Williams Companies ( WMB ) handles natural gas almost exclusively while Plains All American Pipeline transports liquid hydrocarbons. Enterprise Products Partners, Energy Transfer ( ET ), and MPLX ( MPLX ) provide a variety of midstream services in both the liquids and the natural gas product categories. As such, the fund’s holdings provide a reasonable amount of diversity, which is good because the fundamentals of crude oil and natural gas are quite different. For example, natural gas is a critical component of the “energy transition” that politicians and activists keep pushing upon the world, so its growth prospects are somewhat higher than those of crude oil. Both resources are likely to experience demand growth over the coming years, however. As midstream companies make their money based on the volume of resources that they handle and the volume of resources over extended periods is a function of demand, this should position nearly all of these companies for future cash flow growth.
There have been no changes to the ten largest companies in the fund’s portfolio since the last time that we discussed it. However, the weightings of the firms have changed, which is to be expected over a two-month period. After all, a weighting change could simply be the result of one asset outperforming another in the market. It is not necessarily a sign that the fund is actively changing any of its positions. This might lead us to expect that the fund will have a very low annual turnover. This is indeed the case, as the Kayne Anderson Energy Infrastructure Fund only has a 28.20% annual turnover, which is quite low for an equity closed-end fund. This is nice to see because it costs money to trade stocks and other assets, and these expenses are a drag on the portfolio’s performance. The fact that the fund’s annual turnover is reasonably low for an actively managed equity fund is thus nice to see as it should help the fund to keep its expenses down. That makes it much easier for the fund’s management to deliver a competitive total return. Unfortunately, this fund has not performed especially well compared to many of its peers over the past three years. This chart shows the total return of the Kayne Anderson Energy Infrastructure Fund against several other midstream and energy infrastructure closed-end funds over the past three years:
The Kayne Anderson Energy Information Fund delivered an 86.53% total return over the past three years. This outperformed the First Trust Energy Income and Growth Fund ( FEN ), but otherwise, the Kayne Anderson Energy Infrastructure Fund has lagged behind its peers over the period. It remains to be seen whether the recent merger with Kayne Anderson NextGen Energy & Infrastructure will make any difference in terms of the fund’s total return. Of course, past performance is no guarantee of future results and the fund’s portfolio does certainly appear to be decent.
Leverage
As is the case with most closed-end funds, the Kayne Anderson Energy Infrastructure Fund employs leverage as a means of boosting its returns beyond that of any of the underlying assets in the fund. I explained how this works in my previous article on this fund:
Basically, the fund borrows money and then uses that borrowed money to purchase partnership units of midstream companies. As long as the purchased assets have a higher yield than the interest rate that the fund has to pay on the borrowed money, the strategy works pretty well to boost the effective yield of the portfolio. As this fund is capable of borrowing at institutional rates, which are considerably lower than retail rates, this will usually be the case.
However, the use of debt in this fashion is a double-edged sword. This is because leverage boosts both gains and losses. As a result of this, we want to ensure that the fund is not employing too much leverage since that would expose us to too much risk. I generally do not like to see a fund’s leverage exceed a third as a percentage of its assets for that reason.
As of the time of writing, the Kayne Anderson Energy Infrastructure Fund has leveraged assets comprising 22.41% of its portfolio. This is certainly a reasonable level that is in line with the 22.50% leverage that the fund had the last time that we discussed it. As such, it does not appear that the fund has been increasing its leverage despite the fact that midstream companies have generally been on a pretty good run over the past few months. This is a good sign that the fund is trying to maintain a reasonable balance between risk and reward. We should not need to worry about too much here with respect to the fund’s leverage.
Distribution Analysis
As mentioned earlier in this article, the primary objective of the Kayne Anderson Energy Infrastructure Fund is to provide its shareholders with a high level of total return. In order to achieve this objective, the fund invests primarily in the common equity of midstream companies, which tend to boast fairly high yields. After all, as already mentioned, many of these firms provide the overwhelming majority of their total returns via direct payments to their shareholders or limited partners. In this case, that means that it is the fund that receives the money, which it pools with any money that it manages to collect from dividends or distributions from the remainder of the portfolio and any capital gains that it successfully realizes. The fund employs a layer of leverage that allows it to control more securities than it ordinarily could based on its net assets, which results in more money being received from dividends, distributions, and capital gains. The fund then pays out all of the money that it manages to collect to its shareholders, net of its own expenses. We can expect that this process will result in the fund’s shares having a fairly high yield.
This is certainly the case, as the Kayne Anderson Energy Infrastructure Fund currently pays a quarterly distribution of $0.21 per share ($0.84 per share annually), which gives its shares a 10.08% yield at the current price. This is actually one of the highest yields that is currently available from any energy infrastructure fund, which should appeal to any reader who is seeking to earn a very high level of current income from the assets that they have managed to accumulate. However, as is usually the case with energy infrastructure funds, the Kayne Anderson Energy Infrastructure Fund has not been especially consistent with respect to its distribution over the years. We can see this by looking at the fund’s distribution history:
As we can see, the fund has both increased and cut its distribution several times over the years. This is something that might reduce its appeal in the eyes of those investors who are seeking to receive a safe and secure income to use to finance their lifestyles or pay their bills. However, this is not an unexpected situation as most energy infrastructure funds have had to cut their distributions over the years. After all, the past ten years have seen two energy price collapses that caused numerous changes throughout the industry and restricted the ability of midstream companies to access capital. These companies have responded in a variety of ways, which have forced most midstream funds to reduce their payouts in order to avoid destroying their net asset levels. We can see that this fund has generally been increasing its distribution ever since the pandemic though, which is rather appealing considering the adverse impacts that inflation is having on the purchasing power of the distributions that we receive from the assets that are in our portfolios.
The fund’s past history is not necessarily the most important thing for those investors who are purchasing the fund today. After all, today’s buyer will receive the current distribution at the current yield and will not be affected by actions that the fund has had to take in the past. As such, we should investigate the fund’s finances to determine how well it can sustain the current distribution.
Fortunately, we have a relatively recent document that we can consult for the purpose of our analysis. As of the time of writing, the most recent document is the fund’s quarterly report which was linked earlier in this article. This report corresponds to the nine-month period that ended on August 31, 2023, so it is a more recent report than the one that we had available to us the last time that we discussed this fund. That is a nice thing, as the market started to shift in mid-July in a way that generally benefited energy and midstream stocks. That could have provided this fund with the potential to earn some capital gains, which would be reflected in this report. However, this document will not reflect any changes that may have come about as a result of the recent merger between this fund and Kayne Anderson’s other infrastructure fund two weeks ago. However, the only significant change as a result of that merger should be that this fund’s net assets are going to be significantly higher than they were at the time that this report was published.
During the nine-month period, the Kayne Anderson Energy Infrastructure Fund received a total of $90.191 million in dividends and distributions and $178,000 in interest from the investments in its portfolio. However, a significant amount of this money came from master limited partnerships and so was classified as a return of capital as opposed to investment income. Thus, the fund reported a total investment income of $43.972 million during the period. It paid its expenses out of this amount, which left it with $6.386 million available to shareholders. That was obviously not enough to cover the total distributions that the fund paid out, which came out to a whopping $84.402 million over the nine-month period. At first glance, this is something that might be concerning as the fund is clearly not generating enough investment income after expenses to cover its distributions.
However, the fund does have other methods through which it can obtain the money that it needs to cover the distributions. For example, money that it receives from master limited partnerships is not considered to be investment income for tax purposes, even though it clearly represents money coming into the fund. The fund might also be able to realize some capital gains that can be paid out. Fortunately, it did have some success at this task during the period, as the fund reported net realized gains of $40.506 million. These were partially offset by $19.127 million in unrealized losses, but overall, the fund’s numbers were positive. Unfortunately, it was still not enough to cover the $84.402 million that was paid out, and the fund’s net assets declined by $56.637 million over the nine-month period after accounting for all inflows and outflows.
The fund’s net assets at the end of the period were still above the level where they stood on December 1, 2021. At that time, the fund’s net assets were $1.126479 billion but they were at $1.391385 billion as of August 31, 2023. Thus, the fund has covered its distribution over the past seven quarters, and it is overall probably okay to sustain it going forward.
As a result of the merger, the Kayne Anderson Energy Infrastructure Fund reported that its net assets had increased to $1.7 billion as of November 13, 2023.
Valuation
As of November 28, 2023 (the most recent date for which data is available as of the time of writing), the Kayne Anderson Energy Infrastructure Fund has a net asset value of $10.32 per share but the shares currently trade for $8.37 each. This gives the fund’s shares a whopping 18.90% discount on net asset value as of the time of writing. That is not quite as good as the 19.55% discount that the shares have had on average over the past month, but a double-digit discount is pretty much always a reasonable entry point for a closed-end fund that is not suffering from problems that could force a distribution cut. This one is in pretty solid financial shape, so the current price appears to be a very good entry point.
Conclusion
In conclusion, the Kayne Anderson Energy Infrastructure Fund certainly appears to be a very solid fund for anyone who is seeking to add midstream companies to their portfolio and receive a very high yield while doing so. The fund’s assets are solid, as the fund is generally invested in the best midstream companies in the sector, and its 10.08% yield appears to be sustainable. The fund is currently trading at an enormous discount on net asset value, so it appears to be a very attractive purchase right now.
For further details see:
KYN: This Excellent Midstream Fund Has A 10.08% Yield And An Enormous Discount