Written by Nick Ackerman, co-produced by Stanford Chemist
Kayne Anderson NextGen Energy & Infrastructure Inc (KMF) was one of many funds that ceased to be pure energy players when they collapsed in 2020. Several others have just been liquidated entirely to rid themselves of imperfections on the track record of the fund’s sponsors. To stick around, KMF now has an overhanging lack of confidence. One of the highest expense ratios certainly doesn’t help either.
That being said, now that they are transitioning their portfolio, the future looks potentially brighter than the past. Volatility should be reduced with the addition of exposure to utilities and renewables. However, the fund is still leveraged, which will also increase volatility. I believe the significant discount makes it an attractive choice.
However, Tortoise Energy Infrastructure Corp (TYG) took similar steps in terms of portfolio repositioning and outperformance while presenting more shareholder-friendly metrics. I own KMF at the moment, but I think TYG is a viable option to transfer that capital at some point.
- Z-score over 1 year: -0.69
- Discount: 19.07%
- Distribution yield: 7.29%
- Expense ratio: 2.10%
- Leverage: 27.76%
- Assets under management: $587 million
- Structure: Perpetual
KMF aims to “deliver a high level of total return with an emphasis on cash distributions”. They intend to achieve this through “at least 80% of its total assets in securities of energy companies and infrastructure companies”.
Under the infrastructure component, they emphasize “investments focused on ‘NextGen’ energy companies and infrastructure companies that meaningfully participate in or significantly benefit from the ‘Energy Transition’ mega-trend. “. The hybrid approach allows the fund to invest wherever they want. As the ESG momentum continues, this should benefit KMF.
This transition happened in July 2020 when they announced this updated investment policy as well as the fund name change.
The fund’s expense ratio is high at 2.10%. They are leveraged in the form of debt, senior notes and mandatory callable preferred shares. Most of it is fixed rate, which means that when rates go up this year, the impact shouldn’t be too bad for KMF. On the other hand, it has meant expensive interest for the time being. Fixed rate borrowings range from 2.44% on their preferred Series J to 4.07% on the preferred Series H.
With such high leverage spending, the expense ratio climbs to 3.4%. It was the previous exercise. In 2020, the spend rate was 2.3%, with leverage spending pushing it to 5.5%. It is a regulated investment company, which means that this also does not include tax expenditures. C-corp CEFs would also have taxes included in their expense ratio. It is among the highest in the CEF space.
Performance – Attractive discount
Historically, the fund has not provided positive returns in most years, causing standard annualized periods to show negative returns. That’s with the exception of the last one-year period which showed strong returns. This was partly because the energy sector itself had performed so well, meaning that KMF has always participated to some degree in this recovery.
Of course, the returns were pretty strong looking back to 2014/15 when the energy market crashed. Everyone wanted to be in the energy at that time.
Even now, the fund hasn’t produced a positive total return since its inception in 2010. This will apparently affect this fund for some time, as it continues to be heavily discounted. Going back to its creation, we see that the fund’s discount is almost double its average. That being said, the longer the fund stays refreshed, the lower the average will go.
I think the low historical returns and investor aversion to energy investments are likely to keep this fund undervalued to some degree. It was then that the fund repositioned itself.
Payout – 7.29% shareholder payout yield
Currently, the fund’s payout ratio to shareholders of 7.29% is quite attractive. Due to the significant discount, the payout rate on the NAV is only 5.9%. This appears to be a sustainable level for the fund based on the underlying holdings. Currently, this is paid at $0.14 per quarter. This has increased from the $0.09 they started paying after the COVID-induced crash.
Since the fund still has exposure to MLPs and energy, a fairly large portion of the distributions the fund itself will receive will be a return of capital. Along with the higher expense ratio, this means the fund is reporting net investment losses rather than net investment income.
However, if we go back to include the $13.339 million in return of capital, then we see distributable net income. This coverage would amount to 57.6%. In the realm of equities, this is more than a reasonable level of coverage. Capital gains can offset the shortfall in most cases.
For tax purposes, the fund has primarily reported returns of capital over the past 5 years. 2020 was an odd year where ordinary dividends made up the bulk of the distribution. Prior to 2017, the fund benefited from all of these gains and did not have the losses to offset the income and gains.
The Fund’s portfolio turnover rate was 29.7% last year. In 2020, they were more active during their transition, which reached almost 52%.
The latest portfolio composition places midstream energy companies as the largest exposure. However, renewable infrastructure and utility companies also play a significant role in the portfolio at 21% in each basket.
Natural gas and LNG infrastructure also represent a significant portion of KMF’s assets. These are considered a type of bridge energy because they are cleaner than oil and coal. At the same time, renewable energy remains expensive and inadequate to power society at this time. That’s why natural gas can fill the gap during the transition.
Overall, there have been no drastic changes to the wallet since our previous update. This was for the end of September 2021. It seems that for now, their transition seems complete, and they are content with their weightings, given the current context.
For the top ten in the fund, we also see many of the same names. This would remain consistent with the lower turnover rate reported for the year and the absence of sector changes.
Enterprise Product Partners (EPD) probably needs no introduction as this is one of the most MLP games in the space. They focus on transporting and storing natural gas. However, they have also kept an open mind about the alternatives they can branch out into. I believe it will keep them going for a long time besides just being a buncher in space as well.
For KMF, their top ten own a fairly large share of their assets at 43.3%. This is a reduction from the 46.9% it was before, but it is still significant. One of the main reasons for this is that KMF does not hold a significant number of positions overall. The fund last reported 59 positions in total, according to CEFConnect.
KMF won’t get much love due to its track record of poor performance due to its investments in the energy space. However, since the fund’s transition, it should be less volatile due to the inclusion of a handful of more stable utility names in its portfolio. Including more renewables in their portfolio should also give them better long-term prospects as the world moves away from oil. At the same time, they still own many midstream companies that will benefit from oil and gas pipelines and storage.