My Favorite Defensive Holding Pays Nearly 7%
By Genia Turanova | August 16, 2018 |

There aren't too many investments in existence that are truly recession-proof. And even fewer are market-proof. U.S. government bonds, especially Treasury inflation-protected securities (TIPS) and zero-coupon bonds -- the hedges I discussed in this article -- come quite close to being both.


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Utilities, despite their reputation for being recession-resistant investments, are not quite there in terms of their portfolio-protection abilities. For one, demand for energy isn't always steady. Because much of it comes from industrial uses, when a recession hits, overall energy demand usually declines. Furthermore, even a regulated-utility business model -- while making these stocks safer -- hardly guarantees growth. Power companies have to contend with regulation, capital expenditures, the costs of maintaining and upgrading our aging infrastructure, the advent of renewable energy, and the additional costs of providing enhanced cybersecurity.

But they are indeed safer than much of the rest of the market. Society needs these businesses to always operate, and so the government strives to guarantee that regulated utilities have at least some certainty in their businesses. This is achieved via setting up a regulated return on investment for a regulated utility.

Because utilities are largely domestic businesses, their results don't depend on currency fluctuations. This domestic focus will likely make this sector a safe harbor if (and when) the trade war, which seems to be heating up as we speak, emerges as a real threat to the economy.

Investors willing to invest in utilities have some options. They can buy one -- or several -- stocks of related companies, such as Dominion Energy (NYSE: D), for example.

They can also invest in a mutual fund or a low-cost exchange-traded fund (ETF). One popular option is Utilities Select Sector SPRD ETF (NYSE: XLU), at nearly $7.5 billion in size.

Or they can opt for a closed-end fund (CEF), like Wells Fargo Utilities and High Income Fund (NYSE: ERH) or Reaves Utility Income Fund (NYSE: UTG). Both deliver yields much higher than the 3.6% yield of XLU. Most recently, ERH was yielding 7.2% and UTG was yielding 6.7% thanks to the use of leverage.

Coming from a small investment shop that specializes in utilities, UTG is quite an interesting fund. The graphics below tell us why.

My Favorite Utility Fund
First, take a look at the chart that compares UTG with its benchmark utility ETF, XLU, over the past decade.

Many things can be clearly seen from this chart.The lines representing UTG and XLU move quite closely together -- their market action is clearly correlated. That's because both funds are focused on investing in utilities.

Further, UTG does not just mirror the moves in XLU. While the direction is the same, the moves for UTG look much more dramatic than for XLU. That's because UTG is leveraged and XLU is not. In other words, because UTG uses leverage, that leverage magnifies its ups as well as its downs. XLU is calmer; UTG is more volatile.

If you are a relative newcomer to the fund, you might notice that, at least twice, UTG significantly underperformed its benchmark.
The first such occasion was during the Great Recession, when many closed-end funds suffered disproportionately. By 2010, though, UTG has recovered from that slump and then some.

The other such event is due to the rights offering announced last summer and finalized on October 4, 2017. Unfortunately, this also coincided with the utilities market making a top in mid-November. I've discussed this before with readers of my premium newsletter, The Daily Paycheck.

With the utilities on the mend, UTG has started to recover, too.

Over the past year, UTG is still lagging the benchmark; however, judging by its year-to-date relative performance, it's already getting back its mojo. And, as you can see from the table, its past performance, once you reinvest dividends, has left XLU in the dust: 227% for UTG vs 103% for XLU over the past decade (the time period depicted on the chart above), for instance.

And judging by its portfolio, I think it's the fund worth holding on to.

Analyzing Reaves Utility Income Fund (NYSE: UTG)
For income investors looking to potentially buy this fund, prepare to be surprised: UTG isn't simply a utility fund.

This might be something that turns away some "pure play" investors. I, however, like this feature of the fund. While it has enough utility companies to be considered a sector closed-end fund (and to generate income), the managers are not boxed into having to invest 100% of all assets into this sector.

Over time, the results of this investment policy have been quite good. We cannot say anything about the future based purely on the past, of course. But, with two leading managers having been with the fund for decades, consistency of management is there.

I also like the composition of the fund's portfolio. While UTG focuses on utility companies with the ability to grow at about 5%-7% annually, the fund also has a few telecommunication companies -- including wireless ones, media companies, transportation, and a small position in master limited partnerships (MLPs) -- in its portfolio.

The fund values research. Its experienced analysts focus their efforts on bottom-up research -- they start with a company, not with the market -- and identify those companies that can grow their dividends. Portfolio managers then evaluate research analysts' recommendations and determine whether or not -- and when -- to buy (or sell) a stock. Here, market conditions can become a factor. The fund's investments are constantly re-evaluated.

UTG does not have the highest levels of leverage among our portfolio funds, but, at about 26.8%, its leverage allows it to both enhance returns and generate higher dividends.

Reaves Utility Income Fund (NYSE: UTG) is a still good choice for defensive-minded income investors. That's why I recently told my Daily Paycheck readers that we're holding on tight to this fund.

I should also not that while we're up nearly 152% with this holding alone, it's not our only pick that's up big...

But by thinking ahead with a defensive mindset, my Daily Paycheck subscribers and I are no longer anxious about retirement. Our portfolio generates more and more income every month, allowing our followers to either keep growing their income -- or flick the switch and start living a worry-free retirement.

You don't have to be anxious, either. Overall, the portfolio has been roughly 37% less volatile than the market. That represents 37% more sleep-filled nights for subscribers.

If you'd like to learn more about The Daily Paycheck system and join us for the ride, click here.

This article originally appeared on StreetAuthority.com.

 

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