A 15%-Yielding Utility Fund... Or Is It?

Includes: SPY, XLU
by: Josh Arnold

In the search for yield, many investors rightly turn to utilities, as they offer the stability and cash flow to support income-seeking investors. A logical extension of that for many investors is to seek out a mutual fund that offers diversification in utilities and a high yield to meet both goals with minimal effort on the part of the investor. One such fund that has caught the attention of many utility investors is the Gabelli Utilities AAA Fund (MUTF:GABUX), managed by none other than the famous Mario Gabelli. In this article, we'll take a look at the fund and why I think it probably isn't the best choice for yield-seeking investors.

To begin, GABUX is a fund that is focused on generating income for its holders via investing mostly in utilities and telecoms. Morningstar says the fund is about half utility stocks, a quarter telecoms, 15% energy and the rest in other industries. The fund pays out a monthly distribution of 7 cents, which is fantastic considering it trades for only $5.61 as of this writing. That means that the distributions add up to a yield of around 15%, or at least they would if they were actually dividends.

This brings us to the main reason why I don't like GABUX; the fund makes large distributions each month, but they are mostly return of capital and not true dividends. When looking at the distribution of the fund, it appears on the surface that it is yielding 15%, but when you take a closer look, the dividends are actually only good for something like 1% per year ("investment income"), according to Gabelli's website. The rest of the distributions are return of capital or capital gains because GABUX has made it a mission to return 7 cents per share per month to holders; the problem is that the fund doesn't generate anywhere near that much income. Thus, holders are simply returned their capital (or short and long-term capital gains) at a high rate each year.

The other piece of GABUX that makes it a no-go, in my mind, is that it charges an exorbitant fee, 139 basis points per year, to simply return your capital to you and provide you with a yield that is roughly half that of the broader stock market. In other words, you can simply buy the S&P 500 (NYSEARCA:SPY) with almost no management fee and get twice the yield. The other side of that is the fee is taking 140% of the dividend yield of this fund. Since it is only yielding 1%, the expense ratio takes more than the actual dividends paid each year. You are then left with being returned your capital and around 200 basis points of capital gains. Does this sound like a good idea to you?

GABUX is a poorly constructed and expensive fund. There are many better alternatives for income investors out there seeking stable income. For a better choice in utilities, one needn't look further than the SPDR offering, the (NYSEARCA:XLU). In short, stay away from GABUX, because although the distributions make it look like it is yielding 15%, the truth couldn't be further away. The fund charges an enormous fee to return your own capital to you along with short-term capital gains that are subject to higher taxation than dividends. There really isn't anything to like here.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.