Written by Nick Ackerman, co-produced by Stanford Chemist. This article was originally published for members of the CEF/ETF Income Lab on November 3, 2022.
Allspring High Income and Utilities Fund (New York Stock Exchange:ERH) does exactly what its name suggests. It’s It is a closed-end fund that invests in high-income gaming and utilities, which means high-yield bonds or junk bonds. This may seem like an odd combination at first. However, for an income investor, one gets exactly what one is looking for. They are investments that aim for strong income-generating characteristics, despite passing through the asset class category.
As we mentioned last time, this was previously a Wells Fargo (WFC) fund, but was sold and rebranded. Also, since our last update, the fund’s performance has been relatively underperforming compared to the broader market. The S&P 500 is not an appropriate benchmark, but it can give us some context of how the fund is doing relative to the market.
Exposure to utilities earlier this year provided the general defensiveness we often see in the sector. However, higher valuations above historical norms and higher interest rates appear to be taking their toll. Utility names can compete on risk-free returns; with those increases, public services may become less attractive.
The discount has only widened a bit since our July article, but ultimately I’d still feel more comfortable with an even bigger discount right now. That said, for those who have the bottom now, I don’t see a strong reason to sell either. That was a change from when the fund was trading at a high premium, where it made more sense to exit the position.
- 1-year Z-score: -0.72
- Discount: 3.81%
- Distribution yield: 8.18%
- Expense Ratio: 0.93%
- Leverage: 21.85%
- Managed Assets: $137,301 million
- Structure: Perpetual
HRE investment objective is “a high level of current income and moderate capital growth, with an emphasis on providing tax-advantaged dividend income.”
To achieve this goal, the fund will simply invest “approximately 70% of its total assets in a sleeve that focuses on utility common, preferred and convertible preferred stock and approximately 30% of its total assets in a sleeve of American dollars”. -debt denominated below investment grade (high yield).”
Despite the fund’s small size, the expense ratio is generally lower than many other CEFs. Still, a small fund can mean reduced liquidity needs with relatively lower trading volume. Larger investors may find it more difficult to gain a significant position, and getting out may be difficult with a sizeable holding.
When including the leverage charge, the total expense ratio comes to 1.25%. They had LIBOR-based loans but are transitioning to SOFR. Here’s a look at how interest expense has performed over previous periods. Interest rates continue to rise, with the Fed signaling potential rates even higher, meaning costs will continue to rise. Being a slightly leveraged fund, it won’t have as big of an impact, but it will still hurt the fund.
Yield: more realistic discount
Since our previous coverage, the discount has been extended a little more. However, the 1-year z-score decreased at the same time. This is a result of the fund’s discount now being reflected in the last year. Before last year, the fund was trading at what I would call an unusual premium.
This reflects that last year and even in 2020, it is more of an anomaly. The discount being more realistic now, would actually reflect a better level than where the fund had historically traded. With higher interest rates, it could be argued that the discount should be even a bit wider. So, that’s really what makes me want to see a bigger discount before I get too excited about this name.
Given the fund’s approach, it’s not too surprising that they use a blended benchmark. One of the problems with a blended benchmark is that the index remains fixed in allocations, but the fund is actively managed. Therefore, while one period might reflect a fair comparison, ERH’s ability to derive different weights might make another period less relevant to a comparison.
With that warning out of the way, we see that in his last Semi-annual reportstill showed poor performance.
Clearly they are not employing a biased mixed benchmark. That said, the index they used has changed.
2 Source: Allspring Funds Management, LLC. The ERH Combined Index is weighted 70% to the S&P 500 Utilities Index and 30% to the ICE BofA US High Yield Constrained Index. Effective October 15, 2019, the ERH Blend Index changed the high yield index component from the ICE BofA US High Yield Index to the ICE BofA US High Yield Constrained Index to better fit the Fund’s investment strategy. You cannot invest directly in an index
A benchmark provided by the fund can give us an idea of how the fund is performing. I still like to compare it to other CEFs, which may give a better idea of how the fund may be performing, as it is a relatively niche category. For the ERH comparison, I have relied on Virtus Total Return Fund (ZTR), a fund that also employs the rather unique approach of investing in utilities and fixed income. ZTR also invests in investment grade shares, so even that’s not a perfect comparison. Franklin Universal Trust (FT) is also a similar approach to these two. Except they put an even greater emphasis on fixed income.
With that, here are the YTD results of these three funds for comparison purposes. On a total return NAV basis, ERH has outperformed thus far. On a total net asset value return basis, the fund suffered after lowering its highest premium relative to these stocks.
Distribution – Variable but predictable
The fund pays what ends up being a variable amount each month.
However, how it is decided is not completely random. They pay at an average NAV of 7% of the previous 12 months. When the NAV was increasing, this helped increase the payout. With NAV struggling as losses mount heading into the final stretch of the year, the payout is shrinking.
Some investors will not like this payout style as some strive to collect level payouts. On the other hand, it is still quite predictable that the direction the payment will go depends on the direction of the NAV.
in the last fiscal year end, net investment income was relatively flat year over year. The reduction could be due to higher interest expense experienced by the fund.
Interestingly, the NII per share seems to have made a big jump year over year. This may fluctuate a bit due to buybacks and the issuance of new shares due to a DRIP. This is because the average number of shares outstanding may vary from what is reported at the end of the period. Since ERH had been trading at such a high premium, they were issuing shares. Still, I can’t understand why the NII in 2021 would be reported at such a low figure.
We can see that the previous NII for the previous tax year was $4,083,654. They also showed “9,284,282 shares issued and outstanding” in the end of that period. That would result in a NII per share of $0.4398. That seems closer to accuracy, as we can see that the real NII year over year also had a slight decrease.
For comparison, in this latest period, they reported “9,292,296 issued and outstanding shares.” Against the NII we see above, that gives us a NII per share of $0.4335, which is consistent with what the report tells us.
In the end, the NII that is reported is not necessarily important due to the managed distribution that they employ. That is decided by what the fund earns, but as long as the total net assets are correct, that determines the payout, not what the fund earns.
Still, being able to reconcile this would be great. Unfortunately, I don’t have any contacts with Wells Fargo or Allspring to contact.
ERH manages a fairly heavy portfolio of equity exposure. However, that doesn’t necessarily make it an aggressive fund. Since it is allocated to utilities, it could be considered quite conservative compared to funds that invest in more cyclical names.
Since our previous update, actual allocations have been fairly stable, with stocks making up around 70% of the fund. Over the past two years, portfolio turnover has been a bit light relative to the fund’s previous state. In fiscal year 2022, turnover was 23%. 2021 had a turnover of 34%; then, in 2020, it was even higher at 68%. In the two years before that, 2019 and 2018, the portfolio was really actively managed, with 131% and 109% turnover, respectively.
The weighting shown below was at the end of June 30, 2022the latest technical data sheet available.
Given the emphasis on public services, the exhibition here is made up almost entirely of public services. There are only small, basically meaningless allocations to finance, energy, and consumer discretionary. This data is also from the fact sheet as of June 30, 2022.
On the other hand, their fixed income allocations are a bit more diversified. Being a small portion of the portfolio, the importance of each allocation is reduced. That can be a benefit for high-yield bond funds. Since they target investments in below-investment-grade positions, diversification helps limit the negative impact that one or two names could have.
On the other hand, equity positions are lower in the equity stack when it comes time for bankruptcy; they often see no recovery. Still, I wouldn’t be too concerned about the utilities that ERH has, considering they concentrate on investment-grade names with strong financial positions.
Here’s a look at the top 15 holdings as of September 30, 2022.
The ERH discount has opened up a bit more, but it still doesn’t look like a purchase. Given the current environment, I think a fund like ERH could get an even bigger discount before it becomes tempting. If you currently own shares of the fund, I also don’t necessarily see a strong case for selling at this point.