Many utilities are having a hard time growing their businesses (in lieu of acquisitions), because of regulatory issues and their very slow-growing customer bases, says Gross. If utilities use their cash flow for major acquisitions, they don’t have it to pay dividends, he says. FAI is also cautious about the energy sector, he says, because the firm thinks increased technology in the space will keep oil prices down.
On the bond side, FAI has shortened its duration and maturities. As a result, it’s lessened its interest-rate sensitivity. More important, says Gross, 10% to 20% of the firm’s bond portfolio is now maturing every year. FAI can reinvest the proceeds at higher rates rather than being locked in for years at lower rates, he says.
Bong Choi, the director of research for Wetherby Asset Management, a San Francisco-based RIA firm, notes that bond proxies (including utilities, REITs and MLPs) are highly leveraged and will see borrowing costs rise as rates rise. So investors must look closely at leverage and quality of management, he says, “and be very discerning.”
The firm is paying a lot of attention to MLPs for midstream pipeline companies. “The midstream space has been somewhat of an anomaly,” he says, “where you have continuing cheap valuations and incredibly attractive yields relative to other dividend strategies.”
Broadly speaking, yields in the space are 6% to 7%, he says, versus about 2% for the S&P 500, 3% for 10-year Treasurys and low-to-mid single digits for utilities and REITs. The U.S., now in the early stages of exporting natural gas, needs better pipelines, he adds, and President Trump is pushing for infrastructure spending.
Some investors have been turned off by the distribution cuts made over the last few years by midstream MLPs, says Choi. Instead, he argues that the cuts are largely to restructure the industry in a way that sets it up for more long-term resilience.
“You’ve seen incredible improvements in balance sheets,” he says, “and you’ve seen this interesting migration from MLPs to C corps” that should make midstream companies more palatable to institutional investors.
Wetherby Asset Management is looking to boost its exposure to real assets in order to find more income, increase diversification and protect purchasing power as inflation rises, says Choi.
“Income is a way to de-risk an investment in the long term,” he says, “because you are taking out cash as you sort of ride out your investment. Investors’ thirst for yield has continued unabated.”