Reaves: Utilities at a Discount

12/05/2016 8:00 am EST

Focus: FUNDS

Ari Charney

Analyst and Associate Editor, Canadian Edge and Personal Finance

Closed-end funds can trade below their net asset value per share, giving value investors an opportunity to buy a stake in a portfolio at a discount to its current market value, explains Ari Charney, dividend expert and editor of Income without Borders.

One of our longtime favorite funds is Reaves Utility Income Fund (UTG), a closed-end fund that currently yields 6.6% and trades at an 8.4% discount to its net asset value.

Reaves focuses on essential-services companies: electric, gas, telecom, and water utilities, along with a few midstream master limited partnerships.

A year ago, Reaves decided to do a rights offering to raise capital, intending to use the proceeds from the offering to take advantage of the selloff in the utilities space.

Management's timing turned out to be pretty good — the offering closed last December when utilities were limping into the year's end and the energy sector was just a couple months away from its final capitulation.

Reaves has taken full advantage of this year's market dynamics. On a year-to-date basis, the fund has delivered a total return of 18.7%, compared to 9.8% for the broad market and 10.5% for the utilities sector.

Now you're probably wondering how Reaves can offer a distribution that yields 6.6% even though it specializes in selecting stocks that generally yield in the 3% to 5% range.

It uses leverage to enhance its yield, which means it borrows money to expand the size of its portfolio. Right now, for instance, the fund has a leverage ratio of nearly 23%.

During bullish periods this leverage can boost gains. But during bearish periods, it can magnify losses.

It's possible that utilities could get rocked by inflation. But Reaves is trading at a current discount to net asset value that exceeds its longer-term average, which makes it a compelling buy at current prices.

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