2023-11-30 04:53:11 ET
Summary
- Cohen & Steers Infrastructure Fund has been negatively impacted by the current rate cycle and the Fed's hawkish stance.
- The fund's performance has struggled due to rising rates, a weakening economy, and expensive leverage.
- The fund's heavy exposure to the utility sector and industrial real estate sector makes it ill-suited for the current high-rate and inflationary environment.
One of the hardest parts about investing is knowing when the market is in a short-term cycle versus a long-term one. While most people have long-term financial strategies that they use, people still have to be able to adapt to the economic and investing environment.
The current rate cycle has impacted investors of all kinds, but those focused primarily on income have been particularly affected by the Fed's more hawkish stance. The dividend funds that have been hurt the most by Powell's decision to raise and keep rates high have been leveraged investments.
One of the more well-known leveraged closed-ended funds that focuses on income is the Cohen & Steers Infrastructure Fund ( UTF )
Today, I am changing my rating of the Cohen & Steers Infrastructure Fund from sell to strong sell. I last wrote about this closed-ended fund in May of this year. I rated the fund a sell then because of rising rates, a weakening economy, and the increasingly expensive leverage the fund uses. Today, am downgrading the fund because of recent inflation data, the new signs that the economy is likely to remain weak for some time, and because this CEF has not shown the ability to adopt the current rate environment that is likely to remain for some time.
This CEF has performed decently since the fund's inception in March of 2004, rising 420.80% during that time period as measured by total returns, while the S&P 500 ( SPY ) has offered investors total returns of 445.42% during the same two decades. Still, this fund has struggled during the recent rate that started soon after inflation began to accelerate significantly in March of 2021.
This Cohen and Steers fund has $2.88 billion in assets under management and an expense ratio of 2.19%, which includes the cost of the leverage this CEF uses. The current yield of the fund is 8.82%. This fund makes monthly distributions. The cost of the leverage that this fund uses has increased notably with rates moving up. The fund has been 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'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 50.80% utilities, 24.53% industrials, 17.33% energy, 7.21% real estate, .11% technology, and .01% basic materials.. 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 ). The CEF's four largest holdings are NextEra Energy Inc. ( NEE ), American Tower Corporation, Transurban Group ( TRAUF ), and Southern Company ( SO ).
The current rate cycle we are in hurts this fund in three main ways. The Utility sector is a higher debt industry, and increased rates raise the cost of servicing the debt. Rising rates also have increased the cost of leverage this fund uses to make monthly payouts, and also make competing fixed income alternatives more appealing. Investors are generally less willing to pay a premium for leveraged funds such as this CEF when rates are higher. as well, which is the main reason this closed-ended fund trades at a discount to net asset valuation.
The recent inflation data suggests the current rate cycle will likely persist for some time. Energy prices rose significantly in August and the rate of price increases was higher in July and August before falling in September and October.
Even though the rate of inflation has come down the last two months, the increase in prices for two consecutive months after inflation levels fell for twelve consecutive months will likely cause the Fed to be cautious about pausing the current rate cycle. Powell has stated repeatedly that the Fed's target for the rate of inflation is 2%, and the current rate of 3.2% remains well above his goal. The Fed chairman has also said that he expects the battle with inflation to be a long-term effort. Powell reiterated that point earlier this month, and he's tended to react very strongly to market cycles, going back to when he raised rates aggressively in 2018.
Recent economic data should concern investors as well. Growth projections in the EU and Asia continue to fall, and wages in the US are not rising adjusted for inflation even though the unemployment rate remains low in the United States. The World Bank recently revised down growth estimates for China from 4.8% to 4.4% for 2024, and the European Commission also just lowered growth estimates in the EU in 2024 as well by .2 pps. Europe is China's largest partner.
This infrastructure fund is heavily overweight the utility sector, and that industry should continue to struggle in a high-rate environment as these companies face increased costs to service their considerable debt. The weakening economic data should also put pressure on the fund's holdings in the industrial real estate sector as well. While this CEF does have some core energy holdings, most of this fund's exposure to the oil and gas sector is to midstream companies, and this closed-ended fund benefits only minimally from crude and natural gas prices going up. This fund is not well positioned for an inflationary or high-rate environment.
This is also why investors should be concerned by this fund consistently needing to pay out principal to be able to continue to make the monthly payouts.
This CEF has needed to use principal to make regular monthly payouts in six of the last nine months.
There is a scenario where UTF could outperform. If the inflation rates were to come down significantly and the Fed indicated the current rate cycle is likely to end sooner than the market expects, this fund could likely attract new capital from dividend and income investors. Lower rates would also help the Utility holdings this fund is heavily overweight to as well. The Fed may also reverse course if the economic data worsens significantly. These situations remain unlikely, since the economic data continues to suggest a slowdown but not a severe recession.
Dividend and income investors often have very different goals from traditional individuals focused primarily on growth, but this Cohen and Steers fund has consistently failed to provide inflation-adjusted income or total returns in the current inflationary economic environment that is likely to remain for some time. With rates and inflation likely to remain high for some time, investors should be better able to get inflation-adjusted income in industries such as the oil and gas sector.
For further details see:
UTF: This CEF Is Facing Increasingly Fierce Headwinds