2023-11-21 09:00:00 ET
Summary
- UTF is a utilities closed-end fund that is expected to benefit from a declining rate environment and focus on income-producing assets.
- The macroeconomic landscape suggests a higher likelihood of a recession in 2024, making UTF an attractive investment for its potential capital appreciation.
- As rates start to fall, capital is likely to flow into utilities, infrastructure companies, and real estate, benefiting UTF and its holdings.
CPI and Core CPI came in under the consensus estimates, and we’re headed into one of the most important Fed meetings on Wednesday, December 13 th . The Cohen & Steers Infrastructure Fund ( UTF ) is predominantly a utilities closed-end fund ((CEF)) with a mixture of industrials, energy, and real estate holdings. I am looking for places that should benefit from where I see the economy going in 2024. I believe UTF sets up well for a declining rate environment as more of a focus will be placed on income-producing assets. UTF has an impressive history of generating monthly income for its investors UTF is managed by Cohen & Steers , which has $75.2 billion of assets under management ((AUM)) and decades of experience creating and managing investment products. Unlike big tech, the underlying assets of UTF declined in 2023, pushing UTF lower by -13.64% YTD. It looks like UTF may have found a bottom in October, and I plan on dollar cost averaging into my position to get ahead of the curve in 2024. This was an income play for me, and now I am seeing an investment proposition for both value and distributable income.
Following up on my previous article about UTF
I wrote my initial article about UTF on 3/6/23 ( can be read here ). At the time, I was looking for income-producing investments to diversify my portfolio that exceeded the risk-free rate of return that CDs and T-bills were offering at the time. A lot has changed in the macroeconomic environment since that article as rates continued to increase, a regional banking crisis occurred, and geopolitical tensions mounted. I am following up on that article because my investment thesis has changed on UTF, as I feel it’s not only a strong income-producing machine but an undervalued fund that could see modest capital appreciation in 2024.
After 8 months of data, I believe that the macroeconomic landscape sets up well for UTF
The Fed has continued threading the needle between its dual mandate of maximum employment and price stability, but that ship is about to set sail. Core CPI continues to decline MoM as interest rates have remained higher for longer than many had expected. While there are people on both sides of the debate about whether a soft landing can still be achieved, the data suggests that a recession is more likely to occur in 2024 than be avoided.
Excluding the pandemic, since the late 1970s, whenever the yield curve becomes inverted for more than 3 months, a recession has followed. So far, the yield curve has been inverted for more than a year, and we have still experienced economic growth on a GDP level. While this economic statistic is not a rule that is set in stone, it has been an indicator that many look to as a signal that a recession is on the horizon.
While the inverted yield curve has a strong track record for being an indicator for an upcoming recession, it’s not the indicator I put the most stock in. A recession is a period of economic decline where trade and industrial activity are reduced compared to previous periods. The standard in identifying a recession is 2 consecutive quarters of negative GDP growth. Technically, we wouldn’t know we had a recession or that we were in a recession until one had already occurred or started. For there to be less economic activity, less money needs to be spent on goods and services. This is why I look more toward unemployment and bankruptcies. When unemployment and bankruptcies are up it’s a safe assumption that both consumers and businesses become tighter with their spending.
Going back to 1948, there isn’t necessarily a key unemployment rate that triggers a recession, but rather an incline of roughly 1 percentage point or more in the unemployment rate increasing has been the standard. In some cases, we have witnessed several percentage points of increased unemployment during a recession, but we haven’t seen a recession not occur when unemployment rises. We’re already halfway to the critical metric, as unemployment has increased from 3.4% in April to 3.9% in October. Corporate bankruptcies have also increased QoQ for the past 5 quarters, which leads to higher levels of unemployment. If these trends continue, we could find out that we are currently in a recession or that a recession is rapidly approaching in 2024 based on the GDP prints.
The Fed is in an interesting position, and the CME Group has now signaled that the Fed is done with its tightening cycle. They see a Fed pivot occurring as soon as March, and most likely that a Fed Pivot will have occurred by June. By the end of 2024, they are projecting that rates have the highest probability of being 425-450 bps (32.4%) and a 6.1% chance that rates could be under 400 bps.
While nothing is guaranteed, and the Fed can still achieve a soft landing, the one thing that is as certain as we can get is that they are at the end of their tightening cycle. Inflation is declining, and unemployment is rising. There is less of a reason to be restrictive, especially with debt at all-time highs. This is a strong setup for UTF because utilities, infrastructure, and real estate segments tend to do better in lower-rate environments. In an economic environment that is uncertain and a recession is becoming more probable, these sectors are traditionally looked at as a flight to safety. Real estate has been under pressure due to concerns about refinancing a wall of debt over the next 2 years, but in an environment where the Fed is cutting, this concern becomes less of a headwind for the sector.
Why capital is likely to flow into utilities, infrastructure companies and real estate during a Fed easing cycle which will benefit UTF
Looking at the 10-year chart for total assets in money market accounts , investors started plowing money in when rates exceeded 1.5%, and momentum excelled when the Fed started raising rates coming out of the pandemic. There is no shortage of yield on the sidelines from capital markets. Anyone can find multiple financial institutions offering rates on money market accounts that exceed 5% yields. The latest indicators are showing that a total of $5.73 trillion of assets is parked in money market accounts. As of 11/15/23, assets of retail money market funds increased by $10.52 billion to $2.23 trillion, while assets of institutional money market funds increased by $11.39 billion to $3.50 trillion.
While there are some investors that would never buy a bond or allocate capital toward risk-free investments, that’s not true for all investors. The debate about investing in growth, index funds, or income-producing assets is one that will continue to be discussed for decades to come. The reality is that no 2 investors are alike, and investors ultimately have different goals. There is a segment of the investment community that wants to collect a dividend and utilize the capital markets to produce income. Interest rates are at their highest levels in decades, and we’re seeing the real-time effects as there is more capital sitting in money market accounts. For income investors, there is less of a reason today to take on equity risk to generate income when you can get paid 5% risk-free.
The allure of risk-free assets will start to fade in 2024 if the economic projections are correct. As rates start to fall, investors will look to the capital markets to replace the yield they have become accustomed to generating. They are less likely to sit on the sidelines until the risk-free rate of return declines to under 3% because as capital flows out of money markets, T-bills, and CDs and into the capital markets, it could cause a bull market in underappreciated income-producing assets. Investors will want to get in earlier and lock in a higher yield on their capital rather than trying to squeeze out every last drop of risk-free returns. There will always be a segment of investors who want to keep cash on hand, but these levels of assets in money market accounts is unlikely to remain intact when the Fed pivots because there are certainly investors using money market accounts as a proxy to generate income.
UTF holds assets in three main areas, utilities, industrials, and real estate. The Utilities Select Sector SPDR Fund ETF ( XLU ) has declined by -11.65% YTD and has a yield of 3.4%. The SPDR S&P Global Infrastructure ETF ( GII ) is down -1.47% YTD and yields 3.22%. The Vanguard Real Estate Index Fund ETF Shares ( VNQ ) has declined -4.17% YTD and yields 4.53%. These are 3 of the largest index funds in the utilities, infrastructure, and real estate sectors, and they are all in the red for 2023. Cohen & Steers has built a portfolio of income-producing assets from these sectors and placed them all in their infrastructure fund UTF. As capital flows back into the capital markets, a portion of the cash is likely to be deployed to income procuring assets, and the holdings within UTF should all benefit from an inflow of capital.
UTF’s distributions could set it apart from other investments
Since its inception on 3/28/04 , UTF has generated $33.44 in distributed income , which is 167.2% of its initial price of $20. If I were to annualize the yield over the past 19.5 years, UTF would have generated an ongoing income stream of roughly 8.57% and that’s prior to the impacts of compounding from reinvesting the distributions. I think this is where income investing gets a bad stigma attached to it because people see a share price that is up $0.83 (4.15%) over 19.5 years and immediately move on. The aspect that is overlooked is that this is an income-producing asset that has generated $33.44 or 167.2% of distributed income over its lifetime on top of the initial investment, growing by 4.15% and continuing to generate forward monthly distributable income.
Today, you’re basically getting shares of UTF for around the same price as when they went public and after nearly 2 decades of an established track record. UTF isn’t a small fund, as it has over $2 billion in AUM and invests in some of the most well-known infrastructure companies. UTF is currently yielding 8.93% and has maintained a quarterly distribution of $0.155 since the beginning of 2018. UTF is likely to continue paying its current levels of distributions into 2024 and remain a high-yielding CEF going forward.
Leverage and UTF’s distribution
Something that all current and potential investors should know is that UTF utilizes leverage, and this is how they can maintain such a large distribution. UTF currently has a 32.97% leverage ratio which is pushing the cap of its authorized use of leverage up to 33.33% of its AUM through borrowings, including loans from certain financial institutions and/or the issuance of debt securities. Leverage can create additional risk for investors as it can lead to greater volatility of both the net asset value ((NAV)) and share price. This could put UTF in a basket of risk that doesn’t fit your risk tolerance levels, so if you're interested in UTF, you should look more into its use of leverage.
Conclusion
Shares of UTF have declined by -15.15% since my article on 3/6/23, and their total return has been -9.59% compared to the S&P 500, appreciating by 11.34%. I plan on adding to my position in UTF and using the current weakness as an opportunity to dollar cost average into the position. I think the current macroeconomic landscape sets up well for its underlying assets. As rates start to decline, I believe that a portion of the capital allocated to generating income from risk-free assets will get redeployed into the capital markets and create a bull market for income-producing assets. If this occurs, utilities, infrastructure, and real estate companies should benefit and drive the share price of UTF higher. I am looking at UTF as a position that can continue its tradition of returning large amounts of distributed income to shareholders while appreciating in 2024.
For further details see:
UTF: Infrastructure CEF Yields 8.93%, Sets Up Well For 2024