2023-04-29 02:52:37 ET
Summary
- TYG has seen its discount expand a bit since our last update.
- Energy and utilities were weaker performers in 2023 so far.
- OPEC+ production cuts helped provide some support for energy more recently.
Written by Nick Ackerman, co-produced by Stanford Chemist. This article was originally published to members of the CEF/ETF Income Laboratory on April 14th, 2023.
Tortoise Energy Infrastructure Corp ( TYG ) was a strong performer in the prior two years, largely thanks to its energy exposure. However, in 2023, its energy and utility exposure has been relatively weaker as investors shift back into more growth-oriented investment segments of the market. One thing that helped support energy once again more recently was earlier in April, OPEC+ announced "surprise oil production cuts."
This came after March provided plenty of volatility due to bank failures. Since our last update at the end of 2022, TYG has been a weaker performer for the reasons outlined. Unfortunately, it would appear my timing with updates has been less than ideal. Despite the large discount present in the fund, the underlying performance of portfolio holdings is playing a greater role in seeing losses materialize.
TYG Performance Since Prior Update (Seeking Alpha)
As a leveraged fund, downside moves can be amplified too. Which, we really saw the destructive nature of leverage during the 2020 crash. An additional factor pushing TYG's performance lower was that the fund's discount expanded a bit further from an already deep discount level.
The Basics
- 1-Year Z-score: -1.33
- Discount: 19.50%
- Distribution Yield: 9.31%
- Expense Ratio: 1.47%
- Leverage: 25.61%
- Managed Assets: $577.302 million
- Structure: Perpetual
TYG mentions that the fund is designed to have "exposure to energy infrastructure, long-lived and essential, midstream power and renewable assets." These companies include those that "generate, transport and distribute electricity as well as process, store, distribute and market natural gas, natural gas liquids, refined products, and crude oil." It also has an investment objective to seek a "high level of total return, emphasizing current distributions."
In the closed-end fund structure, there is no K-1 or unrelated business taxable income (UBTI). That means they can be more appropriate for "IRA and tax-exempt suitability."
The fund was previously structured as a C-corp but now has been making moves to qualify as a regulated investment company or RIC now. One of the stipulations for this is the fund can't have more than 25% invested in MLPs. They last reported having around 20%.
However, they still incurred income tax expenses in the prior year. Going forward, should they continue to focus on qualifying as a RIC, the tax expenses shouldn't impact them.
The fund's total expense ratio was last reported as 4.70% in the prior fiscal year if you include the fund's income tax expenses and leverage expenses.
TYG Expenses (Tortoise)
The costs of its leverage are rising on its credit facility as interest rates rise. They pay 1-month LIBOR plus 1.10%. However, the fund also employs senior notes and mandatory redeemable preferred stock with varying rates but rates that are fixed. The notes they carried at the end of November 2022 were $81.632 million, and the preferred outstanding was $35.661 million. In total, they noted that 79.3% of their leverage was fixed.
At year-end, the fund was in compliance with applicable coverage ratios, 79.3% of the leverage cost was fixed, the weighted-average maturity was 2.3 years and the weighted-average annual rate on leverage was 3.93%. These rates will vary in the future as a result of changing floating rates, utilization of the fund’s credit facility and as leverage and swaps mature or are redeemed.
So most of the higher interest rate costs haven't taken hold yet, and they have a couple of years where they should remain largely hedged.
Performance - Attractive Discount
Energy and utilities have been the laggard sectors on a YTD basis, only besting out financials. Of course, financials have had bigger headaches due to bank failures. XLE is essentially flat for the year as measured by the Energy Select Sector SPDR ( XLE ), and utilities are slightly down as measured by the Utilities Select Sector SPDR ETF ( XLU ).
With results such as these in these sectors where TYG is invested, it's quite expected to see negative results for TYG itself on a YTD basis. Leverage plays a role in greater downside moves but can also help produce higher returns when things are going well.
YCharts
TYG also has a focus on renewables too, but these days the line is blurred between renewables and traditional energy infrastructure. Utilities and other energy producers continue to push into more and more renewable projects.
I believe the real appeal of TYG is the fund's discount at this time. Since the Covid crash, we've seen the fund's discount remain quite deep though it has been reducing from the levels we saw in 2020.
YCharts
During 2020, we saw significant damage done to the fund due precisely to the leverage - which, at that time, the fund was more of a pure-energy play rather than a more diversified infrastructure fund. So it may never again trade at premiums as it did previously, but I believe it is still at an excessive discount.
One way that investors can benefit from this discount heading into 2023 is the same way we benefited in 2022. That is through the fund's conditional tender offer that is most assuredly going to be triggered again this year. In the prior year, the tender offer saw a reduction of $23.236 million from the fund. However, they also didn't repurchase any common stock as they did in the prior year.
With a recession expected later this year, it seemed quite expected that energy would perform more weakly than we saw in the prior two years when it rebounded significantly from the Covid lows. However, with the OPEC+ production cuts, it seems they will continue to attempt to support higher oil prices. That could give oil prices a bit of a floor.
Distribution - Attractive Managed Target Plan
The fund implemented a managed distribution plan in that they'll target a NAV distribution rate of between 7 and 10%. At first, when energy was pushing higher and helping the fund out, that meant several increases. However, they've maintained a quarterly $0.71 over the last year. At the current 7.49% NAV rate, we are within the target. Of course, this is still well below where they were pre-Covid, as with most of the energy funds.
Having a managed distribution plan can help provide some consistency in the fund's payout, at least in terms of what is expected. Should the fund collapse again in a massive sell-off, they would be expected to cut the payouts again. While that seems bad, it can be a positive in terms of helping to keep assets within the fund instead of over-distributing. On the other hand, should the fund's NAV continue to rise from here, it could suggest further increases in the future.
The fund has seen its negative net investment income turn positive this year.
TYG Annual Report (Tortoise)
That is a positive, but investors may be confused about why NII is negative in the first place or even really low. This is because the fund had held and still does hold a fairly meaningful allocation to MLPs. MLPs pay out distributions that are largely classified as return of capital - which most CEF investors should be familiar with ROC. However, when ROC distributions are received in a fund, they are often listed in the total investment income as a negative figure, meaning it reduces the total investment income of the fund.
For TYG, ROC distributions reduced the fund's total net investment income by around $14.819 million. If we add that with the NII of the fund, we would see a net distributable income or NDI of $16.210 million. That puts NDI coverage at just under 50% for the prior year. Though these figures will change going forward after the fund's tender offer in the prior year. The decline will come in both the amount of income generated falling as well as the total distributions paid to shareholders falling.
TYG's Portfolio
The fund's turnover rate in the last year was 73.84%. That was actually quite active for them as the prior year showed a turnover of 65.30%. Both of those figures were well ahead of the prior three years that came in at 36.79%, 26.35% and 17.96%, respectively. The more active changes in the last couple of years would seemingly be related to the fund shifting out of being a pure-energy play fund and attempting to qualify for RIC status.
While the fund isn't a pure-play energy fund anymore, they still dedicate a significant part of the portfolio to natural gas infrastructure and liquids infrastructure. With the number of MLPs shrinking , it makes sense to become more diversified and focus on midstream C-corps overall.
TYG Asset Allocation (Tortoise)
Including utilities also can provide better stability rather than investing mostly in the much more cyclical energy field. I personally prefer these more hybrid funds rather than investing in pure-play energy funds, which is why I don't own any. Incorporating a broader infrastructure focus can leave the fund better diversified and investing with fewer limitations. It should also, hopefully, avoid the type of moves we saw with the Covid crash.
With that being said, the top ten is still fairly concentrated relative to other diversified equity CEFs that can often hold hundreds of positions. CEFConnect puts the number of holdings at just 31 for TYG.
The top ten make up just over 58%, meaning that these top holdings will play a substantial role in the outcome of TYG. In particular, the top three holdings alone make up almost 25%. That's even more narrow than the top three of ( SPY ) making up ~16%.
The performance of several top holdings shows us that total returns have been mostly muted in the last year. However, a sizeable position in The Williams Companies ( WMB ) would appear to be a detractor in performance. Additionally, Sempra Energy ( SRE ) was also a laggard in the last year.
YCharts
While the fund had a high turnover in the last year, these holdings were some of the largest holdings for a while now, so this performance period remained relevant for TYG. Only SRE doesn't appear as a top position in our early 2022 update . However, the N-PORT for the period ending February 28th, 2022 , shows that SRE was a position in the fund at that time, just not a top holding.
Conclusion
TYG is fairly narrowly concentrated compared to other CEFs, but at the same time still provides a fair bit of diversification across a basket of infrastructure names. The fund's hybrid allocation should see relatively less volatility due to including utility exposure rather than a pure-play energy fund. That also meant relatively lower results when energy was blasting higher too.
The fund's deep discount remains attractive, and this year's conditional tender offer should benefit shareholders who participate as it did last year. Unfortunately, it seems to have done fairly little in limiting the fund's discount more permanently. That isn't that unusual based on what we've seen historically.
For further details see:
TYG: Discount Deepens On This Infrastructure Fund