The Gabelli Utilities (GABUX) Fund: Large Distributions From Utility Investing And A Solid Defense in Uncertain Market Times

In uncertain market times like these, many believe that the best way to generate income is through utilities and other high dividend yielding stocks. Traditionally, investors also turn to the utilities sector to protect against downside market risks. Since not all utilities are created equal and since it is best to diversify among several issues, many investors look to funds. In fact, one closed-end utility mutual fund, run by Mario Gabelli, has been a sector outperformer for many years. It’s called the Gabelli Utilities Fund, and it trades under the symbol GABUX.

Now if you’re in a rush to build equity and garner trading gains, you can stop reading right now. Instead, the GABUX fund seeks both capital appreciation and income generation by investing in dividend-paying common stocks in the utility industry. According to the Fund prospectus, it invests at least 80% of its assets in domestic and foreign companies that provide electricity, gas and water. Its 5 largest holdings include National Fuels Group (NYSE: NFG), NextEra Energy (NYSE: NEE), Southern Union Energy (NYSE: SUG), Southwest Gas Corporation (NYSE: SWX) and Constellation Energy (NYSE: CEG). These are not the stocks that “pop” several dollars in a day, nor by themselves are they going to generate outsized dividends. Instead, they’re simply steady performers, providing power, water and other essential services that will always be needed, whether we are in a bear market or a bull market.

What stands out about the GABUX fund, simply put, is its performance. Last year, GABUX outperformed its direct competition, and easily outpaced gains in the S & P Utility Index. Here is a comparison of investor returns, calculated with reinvestment of distributions, at the end of 2010:

As you can see, in tough market times, even using a defensive strategy doesn’t guarantee returns, but Gabelli’s record with GABUX record speaks for itself. Performance, of course, doesn’t come for free and the fund carries an annual management fee of 1.43%.

For many investors who seek income, GABUX provides a distribution that is even more interesting than its returns. Although GABUX hasn’t raised distributions over the past five years, it currently pays a monthly distribution in excess of 12% on an annualized basis. Moreover, most GABUX distributions are classified as a return on capital, which can have certain short-term tax benefits (amounts attributed as a return of capital reduce the basis and is not taxed at current income rates). In fact, over the past five years 75% of GABUX’s distributions--$3.08 of the $4.20 in distributions—have been a return of capital. That includes 73 cents of the 84 cents distributed in 2010.

One thing that is unique about funds that provide a return of capital is that if you hold the fund long enough, eventually the cost basis of your holdings should reach zero. At this point, the distribution changes classification from being a return of capital to being considered ordinary income. At that point it may make sense to close your position if you are in a tax bracket where your ordinary income tax rates exceed capital gains tax rates.