2023-05-19 09:43:43 ET
Summary
- Rising rates have hurt the Cohen & Steers Infrastructure Fund in multiple ways, and the Fed isn't likely to reverse course soon with inflation rates still at near 5%.
- The Utility sector fund is heavily exposed to continues to struggle, and this industry will likely face near-term headwinds for a while.
- The spread between fixed-income rates and what securities pay has narrowed, so investors won't be as willing to pay up for yield in the current market environment in my view.
Very few tools when investing are all or nothing. Allocating capital is complicated, and often strategies and techniques that work in a certain economic environment, will not be as useful as the investing landscape changes. A lot of closed ended funds were very successful at using leverage over much of the last 10 years in a low-rate environment. The cost to borrow was cheap, and investors were also more willing to pay up for yield, since most fixed-income investments offered only minimal income. Today, the investing environment has changed significantly. Rates have been rising for over a year, the Fed remains committed to lower inflation rates to 2%.
One of the more well-known CEFs that was successful using leverage primarily to maximize income over the last decade was the Cohen & Steers Infrastructure Fund ( UTF ).
UTF's total returns over the last decade were 130.41%. While the S&P 500's ( SPY ) total returns during the same time period were 208%, this fund still performed well. UTF is also focused more on income than the traditional CEFs and other funds, and this closed-ended fund has consistently been making annual payouts of 6-8% for some time.
This fund has struggled with rates increasing and inflation levels at historic highs. There are also warning signs that this CEF is likely to continue face challenges for some time as well.
This fund's total return over the last year is negative 11.36%, and the net asset value has also decline by nearly 7% since the beginning of 2022.
Today I rate this fund as a sell. The Cohen & Steers Infrastructure Fund is increasingly using capital to pay the monthly distributions, and high interest rates have significantly increased the cost of the leverage this fund uses. Higher interest rates have also hurt many of the core real estate and utility holdings that are in debt heavy industries. UTF is likely to continue to struggle in the current high-rate environment that should remain for some time with inflation levels still at nearly 5%.
UTF's primary goal is total returns, with an emphasis on income. The fund allocates capital through the investment in the securities in the infrastructure industry. This fund defines infrastructure as utilities, pipelines, toll roads, airports, railroads, ports, telecommunications companies, and other infrastructure companies. The holdings of the Infrastructure Fund are 48% utilities, 27.34% industrials, 14.95% energy, and 7.82% real estate. This fund also has holding of 15% corporate bonds, and 2% government debt. The overall holdings exceed 100% because this is a leveraged CEF. The most recently updated leverage ratio is 29.05%. Most of the fund's energy holdings are in midstream and gas distribution companies such as Enbridge ( ENB ). The fund's real estate exposure is mostly on the industrial and business side, with holdings such as American Tower Corporation ( AMT ).
A Chart of the Sectors this Fund is invested in (www.cohenandsteers.com/funds/infrastructure-fund/)
This CEF has $3.27 billion in assets under management and an expense ratio of 2.29%. The current yield of the fund is 8.38%. This closed-ended fund makes monthly distributions.
In addition to the cost of the leverage this fund uses rising as interest rate have increased, the utility and real estate sectors this fund is heavily exposed to, both high debt industries, have been significantly impacted by the Fed's more hawkish position as well. The Utilities usually need significant capital to make periodic improvements, and real estate companies often rely heavily on debt for expansion as well, rising rates have hurt both of these businesses. The Utilities are also in a heavily regulated industry, and many companies in this sector have been less willing to pass on rising prices to consumer since regulators in this field tend to be stricter. Finally, rising rates also hurt the company's government and corporate fixed income holdings in debt markets as well.
As UTF's 2022 annual report clearly states the use of leverage hurt this closed-ended fund significantly last year. The 2022 annual report states that,
The Fund employs leverage as part of a yield-enhancement strategy. Leverage, which can increase total return in rising markets (just as it can have the opposite effect in declining markets), significantly detracted from the Fund's performance for the 12-month period ended December 31, 2022.
The cost of the leverage that this fund uses has increased notably with rates moving up. The fund is now paying a 5.2% variable rate for 15% of the CEF's leverage, and a weighted average rate of 2.1% for fixed rate financing, which makes up 85% of the financing cost of the leverage UTF uses. The average term for the fixed rate financing is 3.5 years.
UTF has also been using a significant amount of existing capital to pay several recent distributions.
A Chart of the source of the fund's recent distributions (www.cohenandsteers.com/funds/infrastructure-fund/)
The decline in the net asset value since the beginning of 2022 and increasing expense costs that are occurring primarily because of increasing financing cost for the leverage the fund uses have been a significant part of the reason the fund has been using current capital to make monthly distributions since the end of 2021.
UTF performed very well in a low-rate environment since the financing costs of the leverage that the fund used were cheap and investors were willing to pay up for yield. With rates higher now, the spread between the income paid in debt markets compared to distributions and dividends paid by securities has narrowed. Rising costs and increasing interest rates have significantly hurt the utility and real estate industries as well that are core sectors held by this fund as well. Price levels also remain high, and the Fed has been firm in maintaining a 2% goal for price increases. Powell isn't likely to reverse course anytime soon. While this closed-ended fund performed strongly for two decades since the fund's inception in 2004, income investors should be able to find better alternatives in the current market environment.
For further details see:
UTF: A Fund That Is Likely To Continue To Struggle In This Investing Environment