2023-04-25 22:33:57 ET
Summary
- UTF has been a solid long-term fund for investors, providing regular distributions.
- Infrastructure and utilities will remain relevant even during a recessionary environment.
- Despite the greater volatility, this fund has continued to persistently trade near NAV, only offering fairly shallow discounts for investors to add.
Written by Nick Ackerman, co-produced by Stanford Chemist. This article was originally published to members of the CEF/ETF Income Laboratory on April 11th, 2023.
Cohen & Steers Infrastructure Fund ( UTF ) has been a solid fund for investors over the years. Thanks to the more defensive nature of its holdings, 2022 saw relatively minimal downside compared to other asset classes. That's even considering that this fund leveraged, which worked against the fund last year as well.
For 2023, those more defensive areas have been the laggards due to valuation concerns in the utility space. With declines in this space and the current outlook for a recession, it would seem that a fund such as UTF that invests in essential infrastructure and utilities would remain a fairly attractive place to put cash to work. Even during a recession, these underlying companies' services and products continue to operate.
The fund continues to trade at only a shallow discount, regularly going to a premium despite the market volatility in the last year. Therefore, more patient investors could utilize a dollar-cost averaging approach or be comfortable knowing that if a wider discount does show up, their results will be handicapped. For a longer-term investor who is looking for a steady distribution, that's probably less of a concern.
The Basics
- 1-Year Z-score: -1.68
- Discount: -3.29%
- Distribution Yield: 7.75%
- Expense Ratio: 1.34%
- Leverage: 29.10%
- Managed Assets: $3.264 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."
This leaves them fairly free to invest in just about any infrastructure or utilities they would like, anywhere in the globe and in any part of a company's capital structure. We see this hybrid allocation show up, but the fund does lean towards equity positions regularly.
The fund utilizes leverage to enhance returns potentially. However, that also means volatility increases and risks to the downside increase, as we've seen in the last year. Additionally, for most funds, it meant materially higher interest rates cost. For UTF, though, they were able to hedge a large portion of their leverage, so they aren't experiencing the significantly higher interest rate impact that other funds are on their entire borrowings.
UTF Leverage Facts (Cohen & Steers)
Performance - Tight Discount
Over the longer term, the fund's utilization of leverage seemed to have helped the fund's outperformance relative to the fund's linked index. That seems fairly obvious during a bull market; leverage will provide better results. Of course, in the last year, when things weren't going so well, that leverage was a negative factor. That is reflected in the weaker results we have seen in UTF for the shorter-term time periods.
Despite the greater volatility and the average discount widening out for closed-end funds more broadly, UTF has continued to persistently and stubbornly trade right near its NAV. Perhaps that's a testament to investors' confidence in the fund.
Still, it can make it more difficult to get buying opportunities for those investors that look to capitalize on those sorts of mispricing. That being said, a longer-term investor might have fewer qualms about adding at the current shallow discount.
After all, the actual valuations in the underlying investments play a role, too, not just the fund's own discount. As a point, our last update had UTF trading at a 3.20% premium. While the fund has now shifted to a small discount of -0.66%, the performance of the fund since that time has still done quite well. In fact, the fund's total return even bested the S&P 500 during that time.
UTF Performance Since Prior Update (Seeking Alpha)
Now, if the valuations had been reversed, we would have seen even better results since that period. That's why valuation matters when investing in CEFs. So it's a constant battle of trying to balance out getting a good discount on a fund but also being cognizant of the overall landscape of the current environment too.
Historically speaking, for many years in the earlier part of the last decade, UTF could be bought at a 10-15% discount. It was more in the past few years that its valuation had really taken off. 2021 was truly a shock when it happened, as the fund traded at a premium regularly through most of that year. That's why the current discount looks more appealing than in recent history, but more historically is still generally overvalued from a long-term perspective.
Distribution - Steady And Reasonable
At a low discount, the fund's distribution rate of 7.75% matches closely with the fund's NAV distribution yield of 7.70%. They've been paying the same monthly distribution for many years now. However, for a while, they were a quarterly payer after the GFC. The GFC also marks the only time the fund cut its distribution to shareholders.
The current rate seems more than reasonable, and I don't foresee a distribution cut, barring any black swan event.
The fund's net investment income declined in the last year, so it relies more on capital gains to fund the distribution. That isn't anything too unusual for a mostly equity fund, though, as this is regularly the case.
The reason for the decline was the increasing interest rate costs that most CEFs had experienced. The fund saw its total investment income actually increase from $106.868 million to $108.527 million in the following year. However, interest expenses went from $21.37 million to $27.344 million, thus, representing the biggest factor for the decline in NII.
However, as I said, they are hedged against those interest rate increases. Where we see that show up is in the capital gains section of their report. This is because they are mostly hedged via interest-rate swap contracts. It doesn't produce NII or lower the actual interest rate expenses, but it compensates them by producing gains.
Of those gains produced, they realized nearly $3 million in the prior year. That still meant a shortfall of nearly $6 million in increased borrowing costs for the year. However, the unrealized gains they were sitting on due to swaps came in at a massive $71.5 million.
UTF Realized/Unrealized Gains/Losses (Cohen & Steers (highlights from author))
Also, another important gain generator we see in the above comes via written options. Those are types of gains that can also be enjoyed no matter the market environment too. So with these various levers, they can help continue to contribute to a healthy distribution.
Of course, we can't completely ignore the unrealized losses in the portfolio that we saw. Eventually, if we experience these sorts of declines year after year, there would be a point at which the distribution would start to become questionable. The swaps help when we have rising rates, and the written options help mitigate some of the losses, but they wouldn't be enough on their own to provide the same distribution.
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 is fairly active but not overly so. They last reported a turnover rate of 38% in the prior year. In the last five years, the highest turnover was reported in 2020 and 54%.
The fund's largest exposure is to electric utilities. That's going to provide a sturdy base for the fund and is an excellent example of essential infrastructure. Everybody is going to typically pay their electric bill no matter the type of economic conditions.
UTF Sector Exposure (Cohen & Steers)
Corporate bonds then make an appearance, along with preferreds, at the bottom of this allocation list. Overall, they provided that they are 84% in common equities and 16% in fixed-income/preferred as of their last fact sheet . While the sector diversification breakdown would add up to 17%, I guess there is some rounding going on here. Either way that isn't going to be a meaningful change in the outlook.
Midstream C-corps then make up the next largest exposure in the fund. That's going to be the more cyclical portion of the portfolio. Oil and gas are always going to be essential to some degree, but the actual demand for these products can wane during a slowdown.
The fund also doesn't have a particular focus in terms of geographic exposure, and they include quite a material allocation outside of the U.S. At the same time, the fund carries a commanding 60% to the U.S., representing the heaviest geographic exposure. I believe that having geographic flexibility is a positive feature of UTF due to being able to invest where they want in what they feel is the best deal. That means not having any constraining investing policies that could limit their management. While past performance isn't any future indicator of performance in the future, they've at least shown historically to be successful managers.
UTF Geographic Exposure (Cohen & Steers)
Similar to the other metrics they share, they haven't updated their top holdings since the end of 2022. That being said, while the fund is fairly active in managing positions reflected by the fund's turnover, the top holdings don't generally change too drastically.
As a point, NextEra Energy ( NEE ) remained in the top position at the end of 2022, just as it was at the end of June 2022. This was the case even earlier in 2022 as well . In fact, the allocation of 5.6% compares similarly to the 5.4% it was listed in each of the previous updates. NEE remains a highly popular stock seen in most utility/infrastructure-related funds.
FirstEnergy Corp. ( FE ), PPL Corporation ( PPL ) and Alliant Energy Corporation ( LNT ) are new names to the top ten; all are electric utility companies. While all three are new names to the top ten list that we hadn't seen in mid-2022, they were all still holdings within the fund previously .
FE and LNT both had the same number of shares being held at the end of June 2022 as they did at the end of 2022. PPL actually saw the number of shares increase to 2,432,937 from 864,848 shares, making it a significant increase and helping to contribute to the fund's much higher allocation now.
Conclusion
UTF invests in a portfolio of utilities and infrastructure plays that will remain essential even during an economic slowdown. While the energy sleeve might be more volatile, it is balanced with its overweight allocation to utilities. This sort of stability should continue to provide distributions for UTF's shareholders going forward. They also have been benefiting from their interest rate swaps and the contribution of options premiums to help provide more stability.
The track record of this fund has been pretty impressive, but the caution continues to be the fund's narrow discount. Without showing a meaningful discount, there is no sort of added bonus upside that could be expected unless the fund goes back into the more unusually elevated premium levels we saw in 2021.
For further details see:
UTF: Strong Long-Term Infrastructure Fund To Consider