I received an email recently regarding the Cohen & Steers Select Utility Fund (NYSE:UTF) from GroovyStocks.com who noticed that the discount is currently upwards of 16%. Often this type of discount is reserved for funds like Foxby Corp (FXX) and Equus II (NYSE:EQS), which have had less than stellar long-term returns. I think UTF is a decent fund, so I have been buying shares when the discount has been around 16-17%.
I’ve noticed that almost all utility funds are currently trading near their highest discounts of the past several years, and I think there are a few reasons investors are avoiding them. One reason is that utilities in general have been one of the hottest sectors over the last several years. Contrarian investors who like to invest in out of favor sectors have to consider whether this out-performance will be followed by a long period of under-performance. In addition, utility stocks have not been performing as well recently, which may be causing momentum type investors to lose interest in utility funds.
Another reason investors may be avoiding closed-end utility funds is that the investments are so leveraged. Utilities themselves are leveraged, and the closed-end funds that invest in them are usually highly leveraged. So when there is a lot of uncertainty about where interest rates are headed, a risk-averse investor may not want to invest in these funds.
I think the discounts for utility funds in general and for UTF specifically are ultimately supply and demand issues. There may be more investors who have issues with the recent performance of utilities, or who have concerns about the interest rate risk of the funds, than there are investors who want to invest in closed-end utility funds right now.
In contrast, a lot of my decision on when to buy a fund is based on the discount. When I get the chance to buy a decent fund at a 17% discount, I will usually take advantage of it. I won’t try to outguess the market on where interest rates are going, or how utilities will perform over the next five years, but I will make the bet that UTF’s discount will be substantially lower at some point over the next five years.
So whatever the NAV return is, I expect to pick up at least a few percentage points of market return from the decreasing discount. I could be wrong about this in the case of UTF, but I believe that consistently buying funds at large discounts will lead to good long-term returns.
UTF 1-yr chart: