Co-produced with PendragonY
Both Democrats and Republicans Have Infrastructure Spending Plans
The U.S. is headed for a national election at the start of November. And while both parties promise a lot of very different things, both are set to increase spending on infrastructure. The Democrats have all proposed significant new spending, with the Green New Deal being one such proposal. But President Trump and the Republicans have their infrastructure plans as well. So no matter what outcome the election has, infrastructure spending is set to increase significantly.
Coal-fired power plants also are getting older, and those older plants are being replaced – in many cases, some of the capacity is being replaced by wind or solar power. In Texas, wind farms are being built as there are many areas where they are very productive. Other areas are good for solar power, and so such sites increase as well. And in many places, natural gas is part of the replacement picture. These replacement technologies all have different requirements and so will need new transmission lines and other support. And this will require more spending. For instance, several wind farms in Texas have run into problems shipping off the power they generate. New transmission lines are needed to allow them to ship all the power they generate.
Finally, the COVID-19 pandemic has shifted where people work and play. This too will shift the needs for utilities and other infrastructure that will require more investments.
So, what’s the best way to invest to take advantage of all this coming spending and earn high yields? Take a look at these two closed-end funds:
- Cohen & Steers Infrastructure Fund (UTF) – yield 8.1% (paid monthly)
- Reaves Utility Income Fund (UTG) – yield 6.7% (paid monthly)
Both will provide immediate diversification no matter who wins the election. And we like to invest in CEFs better than ETFs because the active management of CEFs allows the managers to invest more in companies before the stock price goes up. Furthermore, the managers are able to underweight or overweight certain companies and adjust the CEF’s portfolio continuously.
Pick #1: UTF
We have frequently pointed out that Cohen & Steers is one of the best CEF managers in the utilities space. The plot below shows exactly why.
Since inception, a $10,000 investment in UTF is now worth $45,210, while that same money the S&P 500 index (SPY) is only worth $40,760. And UTF totally crushes SPY on an income metric with a yield of 8.1% to SPY’s yield of 1.6%.
Below are the top holdings of UTF:
Source : UTF website – Sept. 30, 2020
- Duke Energy (DUK) and National Grid PLC (NGG) are two power distribution and utility companies. Duke generates and distributes electricity and natural gas in the Carolinas, Florida, and the Midwest. National Grid has electricity and natural gas distribution networks in the U.K and U.S, with operations and facilities in upstate New York and New England. Both companies have investments in renewable energy as well.
- Crown Castle (CCI) and American Tower (AMT) are two REITs that own cell towers. With the deployment of 5G, these will both see a lot of growth. CCI also builds and manages fiber-optic networks nationwide.
- Norfolk Southern Corp (NSC) and Canadian National Railway (CNI) are both railroads. Railroads will need to be improved to move goods efficiently.
- Enbridge (ENB) has pipelines. While the MLP energy sector has seen hard times and declining share prices, as the economy comes back online it should again see growth. And the low prices could present an opportunity.
- American Water Works (AWK) is a water utility. Everyone needs water, and with the disruptions from COVID-19, and the changes to work and residential patterns this has caused, new development is likely here as well.
Looking at sector diversification we can see a broad range of holdings as shown in the chart below:
Source : UTF Fact Sheet – June 30, 2020
- UTF allocated 11% in cell towers which provides access to a growing and profitable area that also has a fairly reliable income (no one can be without their cell phone).
- Airports are the one area that might struggle for a while, but that also could present management with the ability to pick up more assets at low prices.
- The holdings in preferred shares and corporate bonds also provide reliable and stable income.
Geographic diversification also provides a nice balance.
Source: UTF Fact Sheet
Just under 60% of assets are in the United States, which still leaves 40% for other holdings in the rest of the world. Most of the other countries are in the developed world. UTF has some exposure to China, Brazil, and Singapore which are growing fast and infrastructure spending could grow significantly.
UTF does use 27.9% leverage to boost its returns and to provide a higher level of income to investors. Management fees of 1.17% are fairly modest compared to the average CEF and still leave enough income for an attractive dividend that produces a current yield of approximately 8%. The CEF also incurs another 1.14% in leverage expenses, but it’s worth to note that the managers have performed exceptionally well, and therefore maximized profits by using the leverage.
Currently UTF trades at a 1.7% discount to its net asset value, which provide a nice entry point for investors.
Pick #2: UTG
The Reaves Utility Income Fund (UTG) is another favorite of ours and the chart below shows why.
Since inception (and remember inception often is not the best time to invest in a CEF) $10K invested in UTG has turned into $50,730 while that same amount of cash has only turned into $41,220 if it was used to buy the S&P 500 Index. And just like its peer UTF, the 6.7% yield of UTG produces income far in excess of SPY.
From the list of top-10 holdings, we can see that UTG has very similar holdings to UTF. Let’s take a look:
Source: UTG website
Both CEFs have NextEra Energy (NEE) as their largest holding. NextEra is a utility company that operates in the US south (Florida is a large part of its operations) and also has a lot of solar power generation.
There are several differences between the two CEFs:
Investments in utilities and infrastructure have two main risks:
- Interest Rate Risk: UTF and UTG both invest in assets that are sensitive to interest rates. However, the expected fast growth in infrastructure spending should compensate for any interest rate increases in the future. Note that is unlikely that the Federal Reserve will increase interest rates before the year 2023, so this CEF should strongly outperform for the next two years at least.
- Poor Market Sentiment: Investors continue to pour money into growth stocks and while income stocks lag the markets. This limits any share price appreciation in the short run. However as long-term investors, we would rather buy cheap stocks rather than overvalued ones. UTF and UTG provide this opportunity. The infrastructure sector is a fundamentally strong and a defensive sector which carries less price volatility than the general markets. So this sector fits well in any income-oriented portfolio.
UTG and UTF tend to perform well during recessions. Even during a recession, people need to have electricity, heat, water and Internet. So utilities and infrastructure tend to be fairly inelastic. Also, governments often use infrastructure spending to help the economy when it’s struggling. During the last recession, UTG did not cut its distribution and even paid a special distribution. UTF did even better and increased its distribution. Share prices will pull back, but significantly less than the general market. They also tend to recover much sooner once the worst of the recession is over. This can present a good opportunity given the reliability of the distribution.
The COVID-19 pandemic has resulted in increased government spending. No matter who wins the elections, both candidates have set out plans to boost infrastructure spending to help the economy recover.
As such, investing in infrastructure/utilities is set to be very lucrative. We favor two CEFs, UTG and UTF, to get immediate diversification in this space. If you want to invest in a fund, picking a good management team is key, and here you are getting the best managers for the sector. Spending on infrastructure will be increased no matter what party wins the election. It’s just a matter of where exactly that money will be directed. UTG and UTF should be easily able to take advantage whoever wins. Both CEFs have strongly outperformed the S&P 500 index over the long term. Importantly, the utilities/infrastructure sector is a less volatile one (and more defensive in nature) than the general markets, including the S&P 500 index. Therefore, UTF and UTG can somewhat buffer your portfolio in case of a wide market fluctuations.
UTF with a yield of 8.1%, and UTG with a yield 6.7% yield offer an attractive entry point to invest in an undervalued sector with a very promising future. An extra added feature for income investors is that the dividend is paid monthly, which is great for those who like to receive a monthly paycheck.
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Disclosure: I am/we are long UTF AND UTG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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