TYG: Performance Laggard With No Near-Term Catalyst

seekingalpha03-24

Tortoise Energy Infrastructure Corp. is a closed-end fund that invests in midstream and renewable energy companies to provide high current income.The fund has underperformed the S&P 500 Index and ...

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(NYSE:TYG) is a closed-end fund that invests in midstream and, to a lesser extent, renewable energy companies with the goal of providing its investors with a high level of current income from these assets. This fund helps investors resolve one of the biggest challenges that they face when investing in some of these companies, as energy infrastructure companies that are structured as master limited partnerships are quite difficult to include in a retirement or similar account without facing potential consequences at tax time. Admittedly, though, this challenge is not as big of a deal as it once was due to the fact that many master limited partnerships have restructured themselves as corporations in recent years. However, it does still provide an easy way to add a number of infrastructure companies to your portfolio in one easy trade so it might still be worth considering for that reason. As regular readers may remember, we previously discussed Tortoise Energy Infrastructure Corp. in late December of 2023. The market has overall been rather strong since that time, including for energy infrastructure companies. This is something of a departure from the trend that we have seen over the past decade in which midstream and other traditional energy companies did not really participate in market rallies. As a result, we might expect that the fund has performed reasonably well since our last discussion. However, this is not the case as shares of Tortoise Energy Infrastructure Corp. have only risen by 3.10% since the date that the previous article was published: Seeking Alpha As we can see, this is a significantly worse performance than either the S&P 500 Index (SP500) or the Alerian MLP Index (AMLP) managed to deliver from that date. This is something that could certainly prove to be disappointing for any potential investor in the fund as it is never enjoyable to see an asset in your portfolio fail to keep up with everything else in the market. The fact that this fund has underperformed the Alerian MLP Index since the date that the previous article was published is even more disheartening, as the index boasts a 7.42% yield, so it is at least somewhat of an alternative option for an income investor. After all, the 1.29% yield of the S&P 500 Index is not likely to be sufficient to attract an investor whose primary focus is on earning a high level of income. However, as I have pointed out in numerous previous articles, closed-end funds typically pay out most or all of their investment profits to their investors in the form of distributions. The basic objective is to keep the portfolio relatively stable in size while giving the investors all of the profits. This differs somewhat from an exchange-traded fund that rarely has any realized capital gains and relies primarily on share price appreciation to reward its investors. The fact that these funds pay out all of their investment profits is the reason why they tend to have higher yields than just about anything else in the market. It also results in shareholders doing much better than the price performance alone would suggest. Therefore, we need to include the distributions that the fund pays out in any discussion of its performance. When we do that, we see that Tortoise Energy Infrastructure Corp. still underperformed the S&P 500 Index but not nearly as badly: Seeking Alpha The biggest problem is that the fund underperforms the midstream master limited partnership index by a significant margin. That is, without a doubt, a long-term problem as the fund underperformed the index significantly over the past three years: Seeking Alpha The fund did at least manage to beat the S&P 500 Index over the trailing three-year period though, which is probably because energy stocks held up very well in 2022 following the outbreak of hostilities involving one of the three largest oil-producing countries in the world. If we go back any further, the fund's performance is quite terrible as the energy price collapse that accompanied the COVID-19 outbreak had a rather devastating impact on any leveraged energy infrastructure fund, including this one. Tortoise Energy Infrastructure Corp. does have a 9.50% current yield that greatly exceeds that of the Alerian MLP Index but that was not sufficient to offset the poor performance. Overall, this fund's past performance history is not likely to win it any fans but it is always most important to look at the fund's current situation and where it is likely to be in the future rather than dwelling on the past. About The Fund According to the fund's website, Tortoise Energy Infrastructure Corp. has the primary objective of providing its investors with a very high level of total return. This makes a lot of sense when we consider the strategy that is employed by the fund. The website explains this strategy thusly: Positioned to benefit from growing energy demand and accelerated efforts to reduce global CO2 emissions in energy production, TYG invests in energy infrastructure companies that generate, transport and distribute electricity as well as process, store, distribute and market natural gas, natural gas liquids, refined products, and crude oil. The description on the website is not clear on this, but the fund invests in common equities of companies that engage in the businesses listed above. The fund's annual report provides this asset allocation:   Security Type Weighting In Fund   Common Stock 101.1%   Master Limited Partnerships 22.9%   Private Investment 3.8%   Preferred Stock 1.2%   Money Market Fund 0.1%   Click to enlarge As is immediately apparent, the fund's asset weightings exceed 100%. In fact, the common stock allocation alone exceeds 100%. This is possible because this fund employs leverage as a method of boosting the effective yield and total return that it obtains from the securities in its portfolio. We will discuss this in more detail later in this article. For now, the most important thing is that the fund invests primarily in common equity securities issued by companies engaged in the movement of energy supplies and resources. As this fund invests primarily in common equity securities, the fund's focus on total return as its objective makes a great deal of sense. As I pointed out in my previous article on this fund: Common equity is by its very nature a total return investment vehicle. After all, investors purchase common equity securities because they want to earn a certain amount of income via the distributions and dividends that these securities pay out to their owners. In addition, investors are frequently seeking the capital appreciation that typically accompanies the growth and prosperity of the issuing company. The proportion of the total return that will be delivered in the form of capital appreciation as opposed to dividends depends on the individual company and the sector that the company is in. Tortoise Energy Infrastructure expects that a significant proportion of the total return that it generates from the assets in its portfolio will be in the form of dividends and distributions. This is a natural assumption when we consider the assets in the fund's portfolio. Here are the largest positions in the fund today: Tortoise Ecofin These ten positions alone account for 61.7% of the fund's total assets so we can see that it is clearly very heavily concentrated in fairly few companies. The entire portfolio only includes 29 names (plus a money market fund) so investors in this fund will need to have a lot of confidence in only a few companies as there is not a lot of diversification here. This is fairly typical for an energy infrastructure fund, however. After all, the Alerian MLP Index only has fifteen positions (plus a money market/cash position) as there are relatively few midstream companies in existence. Here are the current yields of these companies:   Company Current Yield   The Williams Companies (WMB) 4.94%   Targa Resources Corp. (TRGP) 1.80%   Sempra (SRE) 3.55%   MPLX (MPLX) 8.36%   Hess Midstream (HESM) 7.08%   Energy Transfer (ET) 8.08%   Constellation Energy (CEG) 0.81%   ONEOK (OKE) 4.98%   Kinder Morgan (KMI) 6.24%   Enterprise Products Partners (EPD) 7.16%   Click to enlarge As mentioned in the introduction to this article, the SPDR S&P 500 ETF Trust (SPY), which is the largest exchange-traded index fund tracking the S&P 500 Index, has a trailing twelve-month distribution yield of 1.29% today. We can therefore see that nine of the ten largest companies in the fund's portfolio have yields well in excess of this. This tells us that the fund will probably derive a greater proportion of its total returns from distributions and dividends than the broader equity market. After all, there is supposedly an inverse relationship between dividend yield and capital appreciation. If that were not the case, value stocks would be consistently beating growth stocks in terms of total returns. Over the past ten years, I certainly have not seen people get as excited about a company like Sempra Energy as they have been about Tesla (TSLA), Apple (AAPL), or NVIDIA (NVDA) so we know that it is not the case that value-priced high-yielding dividend stocks shown above are historically delivering better gains than low-yielding growth stocks. With that said, many of the companies shown above do deliver reasonably solid total returns when the dividend is added to their capital gains (or used to reinvest in new shares). As such, we can clearly see that Tortoise Energy Infrastructure Corp. is not simply buying the same stocks as a typical equity closed-end fund. Rather, it will collect a fairly high yield from the assets in the portfolio as well as benefit from a bit of capital appreciation in addition to this yield. At least, that is the fund's basic objective. One thing that we note here is that this fund substantially underperformed the Alerian MLP Index over the past three years. This chart shows the fund's net asset value against the index over the period: Barchart Over the past three years, the Alerian MLP Index has gained 52.86% but the fund's net asset value has only managed to deliver a 17.94% gain. That is a very disappointing performance, especially considering that this is an energy infrastructure fund. However, one explanation might be found in the fund's holdings. Tortoise Energy Infrastructure Corp. tends to hold a substantial percentage of its assets in renewable energy and power plays: Tortoise EcoFin As we can see here, renewable energy and electric utilities account for roughly 40% of the fund's holdings. That worked out pretty well for it back in 2021 when interest rates were at 0% and young idealistic investors were buying up renewable energy stocks and other ESG assets with their stimulus checks. However, the renewable energy industry has been suffering from a number of setbacks over the past year as companies such as Orsted (OTCPK:DNNGY) have canceled renewable energy projects due to an inability to make them profitable in an inflationary environment characterized by expensive financing costs. The iShares Global Clean Energy ETF (ICLN) is down 42.67% over the past three years: Seeking Alpha The renewable energy exchange-traded index fund is even down 26.35% over the past twelve months: Seeking Alpha Thus, it appears that renewable energy is nowhere near as promising of an investment when interest rates are well above 0%. The fund's desire to have exposure to this sector is almost certainly responsible for its recent underperformance, as the midstream companies and master limited partnerships in its portfolio have all done much better than this fund over the past few years. This could be problematic for investors, as it is difficult to see a scenario in which the Federal Reserve can cut interest rates to the degree needed to reignite the renewable energy bubble unless it is willing to accept either high inflation or an incredibly severe recession. We have discussed this in various previous articles, principally the ones that I have written covering bond markets and bond funds. That could, unfortunately, result in this fund being somewhat of a chronic underperformer relative to those funds that are focused just on the hydrocarbon sector. Leverage As is the case with most closed-end funds, Tortoise Energy Infrastructure Corp. employs leverage as a method of boosting the effective yield and return that the fund earns from the assets in its portfolio. I explained how this works in my previous article on this fund:  In short, the fund is borrowing money and using that borrowed money to purchase common equities of midstream and renewable companies. As long as the purchased assets deliver a higher total return than the interest rate that the fund has to pay on the borrowed money, the strategy works pretty well to boost the effective yield of the portfolio. As this fund is capable of borrowing money at institutional rates, which are considerably lower than retail rates, this will usually be the case. However, it is important to note that this strategy is not as effective today with interest rates at 6% as it was three years ago when rates were at 0%. However, the use of debt in this fashion is a double-edged sword. This is because leverage boosts both gains and losses. Thus, we want to ensure that the fund is not using too much leverage since that would expose us to too much risk. I generally do not like to see a fund's leverage exceed a third as a percentage of assets for that reason.  As of the time of writing, Tortoise Energy Infrastructure has leveraged assets comprising 22.70% of its portfolio. This represents a slight increase compared to the 22.38% that the fund had the last time that we discussed it, although this is not really much of a change. The fund's net asset value is up 5.11% since the date of our previous discussion: Barchart This would ordinarily result in a decrease in a fund's leverage. After all, if we assume that the fund's leverage remains static then an increase in the fund's net asset value should result in its outstanding debt representing a smaller proportion of the fund's overall portfolio. What we might be seeing here is a lag in data reporting. The fund's website states that Tortoise Energy Infrastructure had $115,893,943 of outstanding debt on March 15, 2024. That gives the fund a leverage ratio of 22.70% as of that date. Meanwhile, CEF Connect states that the fund has $107.705 million in debt outstanding as of March 21, 2024, which gives the fund a 21.07% leverage ratio. Ordinarily, when there is a difference between two sources of information as we see here, I am inclined to consider the fund's website to be the authoritative source. However, in this case, the difference between the two might be due to the different dates and the fact that a fund's borrowings might vary a bit from day to day depending on its margin borrowings and other factors. Thus, the fund's leverage looks to be somewhere between 21% and 23% depending on the date and exactly what borrowings are considered to be leverage. Regardless, the fund's leverage is well below the one-third level that I would ordinarily consider to be acceptable for an equity closed-end fund and it is relatively in line with other energy infrastructure closed-end funds. As such, we should not really need to worry about it too much. Distribution Analysis One of the primary reasons why investors purchase midstream corporations, master limited partnerships, and other energy infrastructure corporations is the very high yields that these entities usually possess. Tortoise Energy Infrastructure Corp. acknowledges this, as the fund specifically states that it expects a sizable proportion of its total return to be in the form of distributions and dividends. We have also already seen that many of the largest positions in this fund have fairly high yields relative to the market. The fund collects these distributions and dividends and pools them together with any capital gains that it manages to realize through the sale of appreciated common equity. The fund takes things a bit further, as it borrows money and uses that borrowed money to purchase more high-yielding common equities than it could afford solely by relying on its own equity capital. This allows the fund to pocket the difference between the interest rate that it has to pay on the borrowed money and the total return that it receives from the purchased assets. The fund then pays out all of the money that it earns from these various activities to its investors, net of its expenses. We might expect that this would allow the fund's shares to boast a fairly high distribution yield. This is certainly the case, as Tortoise Energy Infrastructure pays a quarterly distribution of $0.71 per share ($2.84 per share annually), which gives it a 9.50% yield at the current price. Unfortunately, this fund has not been especially consistent with respect to its distributions over the years: CEF Connect We can see that the fund managed to do reasonably well prior to the outbreak of the coronavirus pandemic and the resultant lockdowns. It then cut the distribution twice as energy prices collapsed and pretty much everything related to the sector declined precipitously. While the fund has been somewhat better since then, the distribution remains far below the levels where it stood prior to the crisis. This will almost certainly prove to be a turn-off for any income-focused investor who is seeking to earn a safe and secure income from the assets in their portfolios. However, many other funds in this sector have a similar history, as the effects of multiple industry crises over the past ten years have weighed heavily on any leveraged portfolio invested in energy infrastructure. We can see that the fund's distribution has been relatively stable since 2022 so that might appeal to some. As I have pointed out before, a fund's distribution history is not necessarily the most important thing for investors who are considering purchasing the fund. This is because anyone who purchases the fund today will receive the current distribution at the current yield and will not be adversely affected by any events that happened in the past. The most important thing for today's investors is how well the fund can sustain its distribution going forward. Let us investigate this. Fortunately, we have a very recent document that we can consult for the purposes of our analysis. As of the time of writing, the most recent financial report for Tortoise Energy Infrastructure Corp. corresponds to the full-year period that ended on November 30, 2023. A link to this report was provided earlier in this article. This report is much newer than the one that we had available to us the last time that we discussed this fund, which is quite nice to see. After all, there were a great many things that occurred during the second half of 2023. The market went from a near-euphoric state to a secular bear over the summer and then reversed course in November and began a bear market that is still going strong. However, these shifts did not have a huge impact on energy stocks, which actually managed to do fairly well during both periods: Barchart That chart shows the iShares U.S. Energy ETF (IYE) and the Alerian MLP ETF over the second half of this fund's fiscal year. As we can see, the energy sector in general did not appear to suffer to nearly the same degree as utilities, bonds, or technology companies did during the summer months. As such, the opportunities for this fund to generate outsized capital gains or suffer large losses were somewhat limited in the period but it still had some movements on the renewable energy side. This report should give us a good idea of how well the fund managed these two differing environments. For the full-year period, Tortoise Energy Infrastructure received $26,504,800 in dividends and distributions along with $524,846 in interest from the assets in its portfolio. However, some of this money came from master limited partnerships and is therefore not considered to be investment income for tax or accounting purposes. As a result, the fund reported a total investment income of $15,759,556 for the full-year period. It paid its expenses out of this amount, which left it with $7,184,296 available for shareholders. As might be expected, that was nowhere near enough to cover the distributions that the fund paid out over the period. This fund paid out a total of $31,779,215 in distributions over the course of the year. This might be concerning at first glance as the fund clearly did not have sufficient net investment income to fully cover its distributions. However, the fund does have other methods through which it can obtain the money that it requires to cover the distribution. For example, it might be able to realize some capital gains by selling common equities that have gone up in price. It also receives a substantial amount of income from master limited partnership distributions that are considered to be a return of capital. These things obviously result in money coming into the fund, but they are not included in net investment income. The fund had mixed success at earning income via these alternative sources. It reported net realized gains totaling $48,885,487 but these were offset by $67,840,820 net unrealized losses. Overall, the fund's net assets declined by $66,121,466 over the period after accounting for all inflows and outflows. As a general rule, if the fund's net investment income plus its net realized gains are more than the distributions then we do not need to worry. That was the case here, as the fund's net assets only went down because of the unrealized losses. Unrealized losses can be erased during periods of market strength, so they are not usually worth panicking over. For the most part, this fund appears to be okay in terms of distribution sustainability, but we should still keep an eye on it in order to ensure that this continues to be the case. Valuation As of March 21, 2024 (the most recent date for which data is available as of the time of writing), Tortoise Energy Infrastructure has a net asset value of $37.47 per share but the shares currently trade for $29.96 each. This gives the fund's shares a massive 20.04% discount on net asset value at the current price. This is a more attractive discount than the 17.69% discount that the shares have averaged over the past month. A double-digit discount on net asset value is generally a reasonable price to pay for any fund. As such, the current entry point looks quite reasonable if you wish to add this fund to your portfolio today. Conclusion In conclusion, Tortoise Energy Infrastructure is an interesting fund that invests in both traditional energy infrastructure companies and emerging renewable energy companies. This combination unfortunately has cost the fund a lot in terms of performance, which is mostly due to renewable energy projects struggling to achieve economic viability in today's high interest rate environment. The midstream portfolio itself looks fine, but this combination does not make a great amount of sense. The fund does trade at a discount and offers a fairly attractive yield right now, though. For now, a hold rating seems to be appropriate for this fund. I cannot see any real catalyst to propel it upward from today's levels despite the massive discount on net asset value. Likewise, there does not appear to be a downside catalyst that would befit a sell rating. Investors who already own this fund might want to just keep the shares that they have and continue to receive the distributions. I cannot see any real reason to purchase it over a traditional energy infrastructure closed-end fund, however.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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