Utilities have become somewhat popular among many investors in our current pandemic-stricken world. This certainly makes a great deal of sense, as the virus has prompted many governments around the world to shut down their economies and put many companies into financial difficulties. Utilities have generally seen their revenues and cash flows hold up much better though, as most people would consider them to be providing a necessary good and they do not want to see their services cut off. In addition to this, utilities are generally one of the highest-yielding sectors in the economy, which is a very appealing thing for investors seeking income in a world where quality bonds are yielding practically nothing. Finally, utilities delivered a reasonably strong performance in 2019, so some investors might simply be riding on the coattails and are hoping for a repeat. Unfortunately, this popularity has also suppressed yields by pushing the share price up.
Fortunately, there is a way to get all the benefits of investing in utilities and get a much more attractive yield. That way is by investing in a utility-focused closed-end fund, which can often boast yields north of 7%. In this article, we will take a look at the Gabelli Utility Trust (NYSE:GUT), which is one of a few such funds, and see if it could be right for your portfolio.
As just mentioned in the introduction, the Gabelli Utility Trust is a closed-end fund focused on the utility sector. According to the fund’s web page, it has a primary goal of delivering long-term growth of capital and income. This is slightly different from many other closed-end funds that focus on providing current income first and foremost, but it is not exactly highly unusual, however.
What may be somewhat unusual is the way that the Gabelli Utility Trust defines a utility. If one were to ask most people to define this type of business, they would likely say that a utility is a company that distributes water, gas, or electricity to homes and businesses within its service area. The Gabelli Utility Trust includes these as well as telecommunications companies within this definition. The fund also includes those companies that supply goods or services to those firms. In theory, that could probably include companies like Cisco Systems (CSCO) or Arista Networks (ANET), which provide switches and networking equipment to telecommunications firms, but it would be highly unusual to see one of these companies included in the portfolio. The inclusion of telecommunications firms could be appealing to some investors though, as they have been at the forefront of technologies like fifth-generation cellular networks that are becoming increasingly important to our daily lives.
Another thing that might be appealing to some investors is the simple fact that the Gabelli Utility Trust is a global fund, meaning that its managers are not limited to national borders and can invest its assets anywhere in the world in order to generate superior returns. I have discussed in a few previous articles (most recently here) that the American market appears to greatly overvalued, so having some sort of international exposure would be a good choice for any investor. With that said though, all of the largest positions in the fund are American companies. We can see that here:
It is unlikely to be a surprise that the largest individual position in the fund is NextEra Energy (NEE), which has become something of a renewable energy darling this year and benefited from a great deal of investor interest that has resulted in it becoming the largest energy company in the United States by market cap. Another major holding here is Eversource Energy (ES), a New England-based utility that has also been making a major push into renewable energy. I discussed Eversource in the past, and in particular, its numerous investments in offshore wind power, which could prove to be a major source of growth for the company over the next several years. Thus, we can clearly see that the management of the Gabelli Utility Trust clearly sees the potential for superior returns in the green energy sector right now, although it is not, strictly speaking, a green fund.
With that said though, while NextEra Energy has certainly performed extremely well over the past year, Eversource has somewhat lagged. As we can see here, NextEra Energy stock is up 28.49% over the past year, but Eversource is only up 6.70% over the same period:
This might be one reason why Eversource’s weighting in the fund is not dramatically lower than NextEra Energy’s. The management might believe that Eversource is currently underperforming compared to its peer, and is wanting to capture the potential uptrend when the market eventually drives up Eversource as well.
As mentioned earlier, the Gabelli Utility Trust also considers telecommunications companies to be utilities. While most of its largest holdings are traditional electric and gas companies, we can see the telecommunications presence here with Verizon (VZ), which is a name that almost any American should recognize. Verizon is one of the largest cellular communications and broadband providers in the United States, along with operating a declining traditional phone network. The company also has made an unsuccessful foray into media production and operates a content delivery network and cloud storage unit, but its core business is the cellular and broadband networks. Overall, the company is a reasonably safe dividend payer with slow and steady growth.
One thing that is nice to see here is that the Gabelli Utility Trust has a great deal of diversity. As long-time readers likely know, I generally do not like to see any single position account for more than 5% of the fund’s assets. That is because this is approximately the level at which a position exposes the portfolio to idiosyncratic risk. Idiosyncratic, or company-specific, risk is the risk that some event will occur that causes a stock to decline whenever its peers or the overall market does not. One example of such an event would be a bankruptcy, which is certainly not unheard of in the utility sector despite the usual stability of these companies. Perhaps most famously, California giant PG&E (PCG) declared bankruptcy in January 2019, after potential liability claims against the company with respect to a wildfire overwhelmed the company’s finances. Over the years, we have also seen bankruptcies from FirstEnergy Corp. (FE), NextEra Energy (NRG), Enron, and others. We generally use diversification to prevent an event like this from sinking our portfolios, but if that position accounts for too large of a position in the portfolio, then diversification does not really work too well. The same thing applies to funds, so it is comforting to see that the Gabelli Utility Trust does not have outsized exposure to any single company.
Utilities are often considered to be sleepy “widows’ and orphans’” stocks by many market participants. This is largely due to the fact that these companies generally have very low growth, so they provide a good portfolio of their return through the dividends that they pay out to investors. As already mentioned too, these companies tend to be very recession-resistant, because most people prioritize paying utility bills during times when money is tight compared to more discretionary expenses, as they will not want to have their utilities cut off. As such, we do not usually see outsized performance from these companies in the stock market, especially when compared to other sectors like technology. These stocks have still delivered a reasonably acceptable performance over the past few years. As we can see here, the iShares U.S. Utilities ETF (IDU) has gained 47.60% over the past five years:
As mentioned in the introduction, 2019 was a very good year for utility stocks, as they gained 20.72% in that year alone. The ETF also pays a dividend, so it is important to note that these figures do not include the reinvestment of dividends. If we do that, then these figures would be quite a bit higher. Overall, the index has delivered a total average annual return of 9.56% over the past five years:
This, unfortunately, substantially beats the Gabelli Utility Trust:
Source: Gabelli Funds
This above chart assumes full investment of all distributions at net asset value, which means that someone who took the distributions as income (as many utility investors are looking for income) would have done even worse. This is rather disappointing.
We can see even more evidence of the fund’s disappointing performance by looking at its historical net asset value per share. This is the value of all of the fund’s assets minus any outstanding debt on a per share basis. As we can see here, the Gabelli Utility Trust has seen its net asset value per share decline over its entire lifetime:
This could be a very real sign that the fund is overdistributing money, which we will discuss in a bit. The share price of the fund does fluctuate around the net asset value per share, but does somewhat track it. Thus, we can assume that an investor who took the distributions as income would have lost principal over the years. In fact, that has generally been true until very recently, depending on when one actually made the investment:
Closed-end funds are somewhat different from ETFs though in that they typically pay out their gains to their investors, while ETFs retain them and simply have their share price increase. As such, it may be a good idea to compare the two funds and see how a hypothetical investment would have fared in each of them. This chart compares the values of a $10,000 investment in both funds assuming the reinvestment of distributions:
As we can see here, our hypothetical investment in both funds was usually around the same value at any given time when based on the fund’s net asset value, although the ETF did pull ahead this year. With that said though, the fund’s price performance was less spectacular, as it usually trades at a discount to net asset value (although right now it is not, as we will soon see). Thus, although the actual assets of the fund delivered similar performance to the ETF, the market price trailed it by a fairly substantial amount. We can therefore conclude that someone who invested in the ETF would have generally been better off than someone who invested in the Gabelli Utility Trust over any given time period, assuming that both investors were reinvesting their distributions.
As is usually the case though, the Gabelli Utility Trust does boast a substantially higher yield than the ETF does. This is fairly typical among closed-end funds and is one of the things that makes them popular among investors seeking income. This is because ETFs only pay out money that they receive from their holdings such as dividends (and other things like interest payments from short-sellers), while closed-end funds pay out things such as capital gains and options income. In some cases though, a closed-end fund may actually pay out more than it generates through income and capital gains. This is destructive to net asset value, and ultimately unsustainable. As such, we want to have a look at how the fund generates its distributions as part of our analysis.
The Gabelli Utility Trust pays out an annualized distribution of $0.60 per share, which gives it a current yield of 7.86%. This is substantially higher than the 2.81% yield boasted by the iShares ETF. Interestingly, the fund classified all of these as dividend distributions:
Source: Fidelity Investments
This means the fund is declaring that all of the money that it is distributing to its investors was paid for by dividends that it received from the utility stocks in its portfolio. If that is the case though, then we should not expect the yield to be so much higher than that of the index ETF. So, let us investigate further. In the first six months of 2020 (the latest period for which data is available), the Gabelli Utility Trust received a total of $4,291,611 in dividends (net of foreign withholding taxes) and another $364,309 in interest, for a total investment income of $4,655,920. After accounting for the fund’s own expenses, it was left with $2,758,628. Of this amount, $2,372,767 was paid to the preferred shareholders. The fund also paid out a total of $16,356,379 to its own common shareholders, nearly all of which was return of capital. The reason why this is being called dividend income as reported to shareholders is a mystery. The fund also saw its net assets decrease by about $60 million, while the comparable index ETF is actually up this year, which is another worrying trend. It appears as though the fund may be overdistributing and could end up being forced to cut its distribution.
As is always the case, it is critical that we do not overpay for any asset in our portfolios. This is because overpaying for an asset is a surefire way to generate sub-optimal returns from it. In the case of a closed-end fund like the Gabelli Utility Trust, the usual way to value it is by looking at a metric known as the net asset value. As we have already discussed, this is the current market value of all of the assets in the fund’s portfolio minus any outstanding debt. In this case too, we would subtract out the amount of money that the preferred stockholders originally provided to the fund. This is, therefore, the amount that the fund’s common stockholders would receive if the fund were immediately shut down and liquidated. As of November 20, 2020 (the latest date for which data was available), the Gabelli Utility Trust had a net asset value of $4.08 per share. However, the fund currently trades for $7.66 per share, representing a substantial 87.75% premium to net asset value. In other words, an investor buying shares of the fund at the current price are paying almost double what they are actually worth. When we combine this with the fund’s somewhat poor performance, this seems like an incredibly high price to pay.
In conclusion, the Gabelli Utility Trust does have a few appealing things about it. In particular, its focus on utilities is something that is rather appealing in our uncertain world due to the general stability of this sector. The fund also boasts a much higher yield than the utilities index, but it appears that this is a double-edged sword, because the fund does not appear to be generating enough income and gains to cover this distribution. It is also substantially overvalued at the current price, and will likely plummet to a fairer valuation at some point. Overall, there are better utility funds out there, so this one appears best avoided.
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Disclosure: I/we 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.