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Shining the CEF Spotlight on DNP Select Income

A long-tenured team manages Duff & Phelps' flagship closed-end fund. 

Sumit Desai, CFA, 03/28/2014

A couple weeks ago, Steve Pikelny highlighted Bronze-rated Aberdeen Asia-Pacific Income FAX as a closed-end fund worth taking a closer look at for investors looking to diversify their regional and currency exposure. This week, we bring the CEF spotlight back to the United States to highlight Silver-rated DNP Select IncomeDNP, a fund managed by the team at Duff and Phelps.

Having launched back in January 1987, this utilities fund has performed respectably over the long term. Over the past 10 years, its 11.4% annualized return on a net asset value basis easily beat the S&P 1500 Utilities Index’s 10% return, while also outpacing the closed- and open-end utility category averages of 10% and 10.6%, respectively. Unfortunately, most of these returns have not accrued to shareholders in recent years. With the dissipation of the fund’s previously sky-high premium (40% as of 2012), share price total returns were only 6.9% over the past 10 years. Investors should expect higher levels of volatility with this leveraged fund over similar nonleveraged funds.

While managers invest across many income-generating stocks, including telecom and energy-related MLPs, they focus primarily on regulated utilities. However, it’s difficult to predict how these stocks will do in the immediate future. On one hand, Morningstar’s equity analysts consider the utility sector about 5% overvalued and note that utilities have a long history of underperforming the broader market when interest rates rise. On the other hand, Warren Buffett showed his hand in his most recent shareholder letter, stating that Berkshire Hathaway utility subsidiary MidAmerican remains on the prowl to acquire high-quality, well-run utilities. This would seem to indicate that, at least on an individual stock basis, some utilities may have room to run. 

People
The fund is managed by Duff & Phelps, a firm with a long history of investing in utilities. The lead manager for the fund is Nathan Partain, D&P’s president and chief investment officer. Partain has been with the firm since the mid-1980s and has managed the fund since 1996. He works closely with a deep bench of portfolio managers and analysts, like Brooks Beittel, who joined D&P in 1987 and was named a manager in 1995, and Daniel Petrisko, who joined the firm in 1997. Beittel and Petrisko focus the fixed-income portion of the fund.

There are several things to like about this management team. First, the continuity and tenure of the portfolio managers and analysts over various economic cycles give the overall team a depth of knowledge within the utilities industry. We also like that manager and analyst ownership of the fund is strong, with Partain owning more than $100,000 in shares, while Beittel owns between $10,000 and $50,000 in shares. Although Petrisko (manager since 2004) does not own shares of the fund, other employees do own sizable stakes. For example, Deborah Jansen, team member since 2001, researches global electric and natural gas industries and does not own shares. Connie Luecke, team member since 1996, researches the global telecommunications sector and owns between $10,000 and $50,000 in shares. Randle Smith, team member since 1996, researches global electric and natural gas industries for the fund and owns between $100,000 and $500,000 in shares.

Process
The fund invests at least 65% of assets in public utilities companies (electric, energy, gas, and telecommunication services). No more than 20% can be invested in international firms, and managers have been reducing exposure to international investments for the past few years. The portfolio holds about 30 to 50 securities and is typically 70% equity (common and preferred), with the remainder in fixed income and REITs. Managers also began adding MLPs in 2012 and hired a portfolio manager in early 2014 dedicated to the MLP space.

Analysts and look for high-yielding and low P/E stocks. They also consider the regulatory environment and form an overall view on their sector. The fund is rebalanced among public-utilities sectors based on profitability views for each sector. Stocks are sold based on relative price appreciation or a fundamental shift in a company's operations or regulatory environment. Bonds are typically rated investment-grade and are diversified among names, sectors, and the yield curve. Fixed-income sales are few, and the sell discipline is similar to that of the equity holdings.

As of Jan. 31, 2014, the fund had 69% common stock, 18% bonds, 11% in MLPs, and another 1% in preferred stock. Most of its assets were invested in electric, gas, and water utilities (73%) and communications (13%). The fund’s top 10 holdings make up about 33% of total assets. Top holdings include Dominion Resources DSempra SRE, and NextEra Energy NEE. Recent additions to the portfolio include Wisconsin Energy WEC, which the team likes for the stable regulatory environment in Wisconsin, and MarkWest Energy Partners MWE, an MLP firm with attractive exposure to growth coming from the Utica and Marcellus shale plays.

Sumit Desai, CFA is a senior stock analyst with Morningstar.

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