Retirees: Keep Your Eyes on Income with CEFs

In a recent blog post, we wrote about the potential opportunities and risks associated with closed-end funds (CEFs) as well as the characteristics that distinguish CEFs from mutual funds and exchange-traded funds (ETFs). This post will continue that discussion and examine the suitability of CEFs for retirees and other income-oriented investors.

 

Potential for attractive retirement income

For many retirees focused on finding income investments with attractive yields, the potential appeal of CEFs extends beyond just the current distribution rate. The managed distribution policies utilized by many CEFs may be attractive to investors seeking not just income, but the potential for consistent distributions from their investment portfolio. The laws governing regulated investment companies require mutual funds to distribute nearly all interest and dividend income, together with realized capital gains, each year. However, the timing and amount of payments usually vary and are not always predictable. On the other hand, many CEFs have received an exemption that allows them to make regular fixed payments on a monthly or quarterly basis.

The permanent capital structure of CEFs may also be an advantage to retirees and future retirees, especially during times of market stress. When redemption requests increase, mutual fund and ETF managers are forced to sell securities at depressed prices to meet redemption obligations. In contrast, CEF investors who wish to sell their shares generally cannot redeem those shares directly with the fund, but rather those investors can sell their shares on an exchange to another investor. This allows the fund to remain invested through times of market stress and continue to generate the income retirees often seek.

While these structural characteristics of CEFs are potentially advantageous for retirees and income-seeking investors, not all CEFs are created equal. Before allocating to these funds, investors should evaluate the fund’s underlying assets to determine whether they align with their investment objectives.

 

Utilities as the backbone of a CEF

 The characteristics of utility and utility-like businesses underpin the managed distribution income objectives and long-term investment view that many CEFs and income-oriented investors seek. These include high barriers to entry, limited competition, and the ability to generate consistent, sustainable cash flow through all market cycles to fund dividend and earnings growth. The essential nature of these businesses may allow patient investors to reap the benefits of steady compounding over time.

John Bartlett, co-portfolio manager of the Reaves Utility Income Fund, spoke about the value of utilities within the CEF structure in a recent interview:  

“Utilities and other essential infrastructure companies that are monopolies or monopoly-like have a history of producing stable and/or growing earnings and dividends, which complement the CEF structure.” Earnings growth for some of these companies could get an additional boost from the Inflation Reduction Act (IRA) which was passed by Congress last year and includes ambitious carbon emission goal targets and government support from tax credits. With projections that IRA-related tax credits will last 10 to 20 years, John believes utility companies potentially could see annual earnings growth of 5–7% during that stretch.

The Fund attempts to build a portfolio of companies that can compound over time, have an attractive yield on cost, and continue to build that income base over time. “The Fund can invest in things that yield a little bit less and grow a little bit more,” John said, adding “Since the Fund’s inception, we’ve never cut its distribution—and we’ve raised it 12 times.”

2023.05 UTG Annual Distributions Per Share

Income, growth, diversification

For income-seeking investors, CEFs can be a valuable tool. Managed distributions, permanent capital structure, and use of leverage1 are key benefits of these funds. We believe it's important to choose CEFs with underlying assets that can support long-term, managed distributions — much like the utility and essential infrastructure stocks in the Reaves Utility Income Fund have throughout the Fund’s nearly 20-year history.

Visit our blog to learn more about CEFs and for our latest views on utility companies.

2023.05 Reaves Subscribe to Our Blog

 

Disclosures and Definitions:
Reaves Asset Management is an investment adviser registered with the Securities and Exchange Commission under the Investment Advisers Act of 1940. Registration does not imply any skill or training. Reaves is a privately held, independently owned “S” corporation organized under the laws of the State of Delaware.

The information provided in this blog does not constitute, and should not be construed as, investment advice or recommendations with respect to the securities and sectors listed. Investors should consider the investment objective, risks, charges and expenses of all investments carefully before investing. Any projections, outlooks or estimates contained herein are forward looking statements based upon specific assumptions and should not be construed as indicative of any actual events that have occurred or may occur.

1 Reaves Utility Income Fund (ticker: UTG) utilizes leverage which is the use of debt to amplify returns from an investment. UTG’s most recently filed Annual Report, dated 10/31/22, reported that leverage totaled $500 million or 25.1% of total net assets. Investors should consider the risks associated with the use of leverage when investing in UTG or other CEFs. A closed-end fund’s use of leverage creates the possibility of higher volatility for the fund’s NAV, market price, distributions and returns. There is no assurance that a fund’s leveraging strategy will be successful.

*The distribution rate calculation is based on the most current dividend rate per share of $0.19 annualized and divided by the 3/31/23 market price of $28.38. The fixed monthly amount distributed per share is subject to change at the discretion of the Fund’s Board of Trustees. Sources of distributions to shareholders may include net invest­ment income, net realized short-term capital gains, net realized long-term capital gains and return of capital. Based on current estimates, the first quarter 2023 distributions were paid from a combination of net realized long-term capital gains (68.4%), net investment income (28.4%), and net realized short-term capital gains (3.2%). The actual amounts and sources of the amounts for tax reporting purposes will depend upon the Fund’s investment experience during the remainder of its fiscal year and may be subject to changes based on tax regulations. If a distribution includes anything other than net investment income, the fund provides a Section 19(a) notice of the best estimate of its distribution sources at that time, available at www.utilityincomefund.com. These estimates may not match the final tax characterization (for the full year’s distributions) contained in shareholders’ 1099-DIV forms after the end of the year. Distribution payments are not guaranteed and dividend rates can vary.

There can be no guarantee that distributions will be paid or that the rate will remain the same.

Qualified dividends are defined as dividends from shares in domestic corporations and certain qualified foreign corporations which have been held for at least a specified minimum period of time, known as a holding period. A non-qualified dividend is one that doesn’t meet IRS requirements to qualify for a lower tax rate. These dividends are also known as ordinary dividends and are taxed as ordinary income. Long-term capital gains tax is a tax on profits from the sale of an asset held for more than a year. The tax rate on such a gain is lower than that of a short-term capital gain held for less than a year. Please consult your tax advisor about the impact of qualified, non-qualified dividends and capital gains.

Yield on cost (YOC) is a measure of dividend yield calculated by dividing a stock’s current dividend by the price initially paid for that stock.

Reaves Asset Management does not currently provide an ESG strategy.

Past results do not guarantee future performance. Further, the investment return and principal value of an investment will fluctuate; thus, investor’s equity, when liquidated, may be worth more or less than the original cost. This document provides only impersonal advice and/or statistical data and is not intended to meet objectives or suitability requirements of any specific individual or account.
All investments involve risk, including loss of principal.

Important Tax Information: Reaves Asset Management and its employees are not in the business of providing tax or legal advice to taxpayers. Any such taxpayer should seek advice based on the taxpayer’s own individual circumstances from an independent tax adviser.
Fees: Net performance reflects the deduction of advisory fees which are described in detail in our Form ADV Part 2A.
Please contact your financial professional, or click the following links, for a copy of Reaves’ Form ADV Part 2A and Form CRS .” Additional information about Reaves may be found on our website:  www.reavesam.com.
2023 © Reaves Asset Management (W. H. Reaves & Co., Inc.)

Risk Considerations for the Reaves Utility Income Fund: The Fund may have elements of risk, including the risk of loss of equity. There is no assurance that the investment process will consistently lead to successful results. An investment concentrated in sectors and industries may involve greater risk and volatility than a more diversified investment.

An investor should consider the investment objectives, risks, charges and expenses carefully before investing. To obtain an annual report or semi-annual report which contains this and other information, please visit weww.utilityincomefund.com or call 1-800-644-5571. Read them carefully before investing.

Paralel Distributors LLC is the distributor of the At-the-Market offering for the Reaves Utility Income Fund. Paralel Distributors LLC is not affiliated with Reaves Asset Management.

 

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