One of our favorite actively-managed funds is actually a closed-end fund, not a mutual fund; it’s a one-stop shop for the sector with holdings that span electric utilities, telecoms, water companies, and MLPs, among others, explains Ari Charney, editor of Personal Finance.
In addition to its diversification, Reaves Utility Income Fund (UTG) emphasizes utilities with strong dividend growth.
A closed-end fund’s share price can trade above or below the underlying prices of the assets it holds.
And that can give value-oriented investors like us an opportunity to buy a stake in a portfolio at a discount to its net asset value (NAV). Reaves, for instance, currently trades at a 7.9% discount.
Another key distinction: Many closed-end funds use leverage to enhance their returns, which can boost their yield significantly, while also adding risk.
As such, if you’re a conservative investor, resist the temptation to put a big chunk of your portfolio in the fund; Reaves should only have a supporting role in your portfolio.
That’s because of its level of borrowing. Currently, Reaves has a leverage ratio of around 25%, which means that for every $1 of capital, 25 cents comes from borrowing.
During bullish periods, this leverage can boost gains. During bearish periods, though, it can magnify losses. In the bear market year of 2008, for example, Reaves’s net asset value dropped nearly 43% or about 14 percentage points more than the average utility.
At the same time, the seasoned management team’s use of leverage has added value over the long-term. During the last ten years, the fund’s NAV grew 10.8% annually, beating the average utility’s return by a significant 2.7 percentage points per year.
The key to this performance is exhaustive fundamental analysis that goes beyond mere number crunching. It also includes interviews with executives, competitors, customers, suppliers, and regulators of the companies the fund invests in.
Many of the fund’s biggest holdings also are among our favorite stocks. In fact, 15 of Reaves’s top 25 holdings are constituents of the growth and income portfolio in our newsletter, Utility Forecaster.
The fund has hardly been a slouch on the dividend-growth front. Over the past five years, Reaves increased its distribution by a total of 31.6%, to 15 cents per month.
Its adjusted expense ratio, at 1.16%, is not cheap compared with mutual or exchange-traded funds, but it’s in line with its closed-end peers.
On a trailing three-year basis, Reaves currently trades at a 7.4% discount to its NAV, which is significantly wider than the 4.7% discount it averaged over the past three years. That’s a compelling value.
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