Co-produced with PendragonY
During periods of economic uncertainties, investing in high-yielding defensive sectors is one of the best investment strategies. Reaves Utility Income Fund (NYSE:UTG) invests in the utility sector which is a non-cyclical sector that invests in some of the best utility companies, including electricity, water, telecom, heating and internet providers. The fund has had no distribution cuts since inception and it survived the Great Recession with its distribution intact. That's proof that the management team can handle uncertain times. The great news today is that investors can buy UTG at a great price.
Let’s review UTG’s performance
Reaves Utility Income Fund is a closed-end fund that invests in utilities and infrastructure companies to provide a high level of after-tax dividend income. With so many people in the U.S. and around the world staying and working from home, utilities will provide a very defensive source of income. So how has the fund done since inception?
Source: CEFConnect
As we can see in the chart above, UTG has most years beaten other funds in its category in either NAV performance, price performance, or both. The fund has beaten similar funds on NAV growth in every year other than 2012. While the share price is somewhat at the whim of the market, we see NAV performance as an indicator of management performance, so UTG management is doing a good job.
Source: Portfolio Visualizer performance of $10K investment
Using Portfolio Visualizer, we can compare a $10,000 investment in UTG and Utilities Select Sector SPDR ETF (XLU). Up until the big crash in the market starting in late February, UTG was doing better on a total return basis (dividends reinvested) than was XLU. Since UTG uses roughly 25% leverage, the drop in share prices caused it to have a bigger drop than XLU. But even with that big drop, since inception, UTG has had a total return CAGR over 9%.
Source: Portfolio Visualizer Income comparison of UTG and XLU
Above we can see how much each position generates in income. Notice that UTG generates considerably more income than does XLU. 2016 was a particularly good year for UTG as it paid a special dividend that year. So in the very defensive utility sector, UTG provides conservative investors (and even those not so conservative) with a high yield that's also very dependable.
Source: Seeking Alpha UTG Performance Page
The chart above shows how NAV and price have moved over the last year. Notice that up until March UTG's share price was at a premium to the NAV. But at the end of March and into April, the price went below NAV. At the end of April, the price moved back to a premium, but a very small one. So right now we have a condition where NAV is increasing and the premium to NAV is lower than it typically is. That can be a good time to buy. We last liked UTG when it was trading around $36, now the distribution is the same, and safe, but the price is almost 20% lower.
Let’s Look Inside UTG
So what companies are we getting when we buy UTG? Here were the top 20 holdings of the fund back in August of 2019, when we last reported on UTG.
Source: UTG Website
DTE Energy (DTE) was its largest holding at the time. It had a solid mix (many of the companies well known) that included utilities, railroads, telecoms, and energy companies. Exxon Mobil (XOM) and Royal Dutch Shell (RDS.A) (RDS.B) were two oil majors it held.
Source: UTG Holdings as of March 2020
Looking at the top 20 this year, we see that NextEra Energy (NEE), a utility company with a lot of renewable energy sources, has replaced DTE as the top holding. We also see that XOM has dropped out of the top 20 holdings. XOM was still trading in the $70s, so this reduction precedes the big drop in share prices of oil companies. Equinix (EQIX), a data center REIT, has joined the top 20. Data center REITs have done fairly well during the current crash so that turns out to have been a good choice. Looking at the list, there are six utilities in the top 20 investments. Dominion Energy (D) is yet another utility that provides electricity and gas to residential customers. All of these utilities should do well with so many people working from home. Even the telecoms in the list should do well as people move to set up or expand home offices.
Source: Seeking Alpha NEE Dividend History
NEE is the top holding of the fund (and now over 5% of the portfolio) and shows why it's a good income stock. We see a steadily-rising dividend with 25 years of raises. And the rate of dividend growth is still accelerating. NEE provides electricity to more than 10 million customers in Florida, and also is positioned to benefit from various green energy mandates. This company is a great source of income for the fund and investors.
Source: Seeking Alpha DTE Dividend History
Above, we see that even though DTE moved down in the list, it is still a good income investment. UTG has so far grown its dividend 11 times since Feb 2004. And we also see why it likely moved down in holding size, as the one-year growth rate is below the CAGR over the last three years. This is a multi-energy utility and provides both electricity and gas to customers. With a large residential base of customers in southeastern Michigan, it too is likely to benefit with so many staying and working at home.
I already own UTF, Should I buy UTG?
The managers Cohen & Steers have a similar fund to UTG which is the Cohen & Steers Infrastructure Fund (UTF). We also like UTF which currently yields 7.3% and is a solid buy too. There are some notable differences. First, UTF has just under half of its holdings in companies based outside of the US, while UTG has over 80% of its holdings in US-based companies, with the rest in companies based in Canada and the U.K. UTF's portfolio also is about 15% fixed income (preferred shares, bonds, and convertible securities) while UTG’s portfolio is mainly into common stock. Below is a list of UTF’s top holdings, which highlights some different holdings in their respective Top 10 list.
UTG Assets and Leverage
Source: CEFConnect
Lastly, we look at the capital structure, leverage, and fees. The fund has nearly $2 billion in assets making it of moderate size. With just over 48 million shares it also has a decent size. Trading volume runs around a quarter million shares a day.
One important issue for a CEF is the amount of leverage it has as there's a legal maximum. The leverage quoted is from the end of last October (that was when UTG released its annual report). Based on changes to NAV (from roughly $35 to a value of $25), for more than a day or so, the leverage number didn’t get above 33%. That didn’t force the fund to sell assets at low prices. With NAV back to about $30, the fund is in a good position.
Generally, with total fees just over 2%, and 0.89% of that due to the cost of its leverage, UTG has reasonable fees for a CEF. Remember that yield is net of these fees.
Valuation and Distribution Coverage
As income investors, the fund’s distribution is important to us. Below, we can see the distributions from UTG from its inception as reported by CEFConnect. There are no cuts and several special dividends paid out over the years, which is what we want to see. Reliable dividend payments make this a very attractive investment for conservative investors, and the low current price makes it attractive for those who seek higher but dependable yields as well.
Source: CEFConnect
Another metric for funds is the total return on NAV. The distribution is safest when the fund can both pay the distribution and grow the NAV. Since the total return on NAV is the distribution plus the change in NAV, we can compare that to the distribution and see that the fund is supporting the distribution.
Above, we see how the total return on NAV performed during the first year of the Great Recession (2008). It's no great surprise that this period saw a decline in the value of the NAV, one much larger than the distribution, resulting in total return on NAV for that year being a fairly large negative number. But, also as reported by CEFConnect, not only was the dividend not cut, it also was paid entirely out of interest income from the fund’s holdings.
Now we look at the past year’s performance. Total return on NAV is negative, but much less than that first year of the Great Recession. And while we aren’t prepared to predict that the worst is now behind us, the fund is currently in better shape than it was over the first year of the Great Recession. Even looking at just the last three months, the total return on NAV is down just under 20%, still much better than the performance during the first year of the Great Recession.
Conclusion
UTG provides exposure to one of the most defensive sectors which is utilities. We all need electricity, water, heating, telecom and Internet, in good and bad times. This is exactly what UTG provides to investors. Furthermore, UTG is actively managed by Reaves, the best managers in the space. UTG pays a monthly $0.18 dividend, which is tax-advantaged. The 2019 tax status of the distribution was 68.7% long-term capital gains, and ~31% Qualified Dividends. The first four dividends this year as reported on the Section 19a report are roughly the same percentages. As of May 3 the yield was at 7.3%.
UTG has steadily grown its dividend 11 times since inception in 2004. Its last dividend increase came in July 2018. This fund has been a dependable source of income and is now at an opportune price. For income investors, this is a buy and hold for the very long term for both income and capital gains. Today, it's one of the largest holdings in my retirement portfolio.
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