Filed pursuant to Rule 425 of the Securities
Act of 1933, as amended
and deemed filed pursuant
to Regulation 14A
under the Securities and
Exchange Act of 1934, as amended
Subject Companies:
Kayne Anderson Energy Infrastructure
Fund, Inc.
Commission File No. 811-21593
Kayne Anderson NextGen
Energy & Infrastructure, Inc.
Commission File No. 811-22467
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April 2023
Dear Fellow Stockholders:
It has been an eventful start to
fiscal 2023 for KYN, its portfolio investments, and the financial markets. All eyes remain fixed upon the Fed; market participants wait
on the edge of their seats to see how the Fed will chart a path forward given above-target levels of inflation, concerns about the banking
sector, and uncertainty about the impact higher interest rates and tighter credit markets will have on economic activity. This will, almost
undoubtedly, be a tricky “needle to thread” for central banks across the globe. Notwithstanding this uncertain backdrop, we
continue to believe that the characteristics of energy infrastructure companies – stable cash flows, high barriers to entry, and
attractive dividend yields – position the sector well to navigate the current macroeconomic environment.
On March 27th, KYN and
Kayne Anderson NextGen Energy & Infrastructure, Inc. (NYSE: KMF) announced that the funds have entered into a definitive merger agreement,
in which KMF will be acquired by KYN. We believe this transaction solidifies KYN as the premier investment vehicle for investors seeking
exposure to the energy infrastructure sector with active management, daily liquidity, and an attractive quarterly distribution.(1)
In this quarterly update, we discuss
the energy infrastructure markets, KYN’s portfolio positioning, and the Company’s year-to-date performance. In summary:
| · | KYN’s Net Asset Return for fiscal Q1 (negative 3.4%) was weak on an absolute
basis, though relative performance was favorable (outperformed benchmark by 180 basis points);(2)(3)(4) |
| · | KYN maintained conservative leverage levels with ample downside cushion during
the quarter and through the more volatile month of March;(5) |
| · | Portfolio investments announced solid Q4 2022 earnings during the quarter, with
the majority of companies publishing 2023 guidance that met or exceeded consensus estimates; and |
| · | On March 27th, KYN announced (1) an increase in its quarterly distribution
to be paid April 17th to $0.21 per share (5% increase) and (2) its intention to recommend an additional one cent per share
increase (to $0.22 per share; cumulative 10% increase) upon the close of its combination with KMF. |
Market Conditions
While our goal in these communications
is to recap performance from the recently completed fiscal period (in this case, performance data from KYN’s fiscal quarter ended
February 28th), we also believe it is appropriate to discuss events that have occurred since quarter end. Given the recent
upheaval in the banking sector and higher-than-normal volatility in financial markets during March – on the heels of what was a
fairly quiet fiscal Q1 – this quarterly update will include an above average amount of commentary on recent events.
Broad equity indices and energy-related
stocks were generally under pressure during fiscal Q1, as expectations for additional interest rate hikes and a “higher for longer”
rate outlook weighed on market sentiment. The total returns for the S&P 500 and Dow Jones Industrial Average were -2.3% and -5.2%
(respectively), while the NASDAQ was flat during fiscal Q1. While the market remained sensitive to economic data during the quarter, day-to-day
volatility was down meaningfully from average levels during fiscal 2022. March, however, brought a dramatic spike in volatility, driven
primarily by (1) stubbornly high inflation data (and subsequent hawkish comments from the Fed) and (2) sudden bank failures and a general
loss of confidence in several other regional banks.
Endnotes can be found on
page 5.
Yields on the 10-Year Treasury
increased approximately 20 basis points (bps) during fiscal Q1, ending the quarter at 3.9% while the 2-Year Treasury yielded 4.8%. An
inversion of this magnitude between these two treasury securities has not been seen since prior to the Global Financial Crisis. Furthermore,
it is a measure frequently used by market commentators to “cut through the noise” and suggest that a recession is imminent.
March brought extraordinary moves in interest rates as market participants digested the potential policy responses to the aforementioned
bank failures and positioned towards more risk-averse investments. The 2-Year Treasury yield rose above 5% and then dropped 100 bps over
two trading days (Friday, March 10th – Monday, March 13th). As of this writing, interest rates remain well
below February 28th levels, and the 2-Year to 10-Year Treasury spread is closer to 40 bps (yield curve remains inverted, but
less so than at the end of February).
Crude oil prices were flat during
fiscal Q1, followed by a 10% “risk off” decline in the month of March before settling at $76 per barrel as of March 31st.
In early April, OPEC+ surprised the market with an unexpected production cut, facilitating a rebound in prices to roughly $80 per barrel.
We continue to expect global oil demand growth of ~2 million barrels per day in 2023 (on a year-over-year basis), with U.S. crude production
growing ~0.5 million barrels per day as domestic producers largely remain disciplined on spending and production growth. Recently, the
debate over the trajectory and ultimate peak for domestic oil production has received lots of attention. Our view is that these headlines
often reflect “moment in time” sentiment rather than thoughtful analysis of the many factors that influence production trends.
While the rate of growth will likely moderate, we believe U.S. production will grow in the 3% to 5% area on an annual basis for the next
several years.
The story of the quarter in energy
commodities was natural gas, as 2023 strip prices decreased from $5.57 per million British thermal units (MMBtu) at the end of November
to $3.05/MMBtu as of March 31st. While fundamentals are better over the longer term, the globalization of the natural gas market
has created an environment in which U.S. prices are subject to more short-term volatility than in years past. Domestic and international
weather, regional gas inventories, and economic data from all over the world are among the innumerable factors influencing spot natural
gas prices. A warmer winter globally kept international gas inventories comfortably above 5-year averages and caused domestic natural
gas prices to decline. Focusing on the medium and longer-term outlook – domestic liquefaction projects (LNG exports) and the continued
need for European and Asian markets to source volumes to satisfy growing demand have us optimistic about U.S. prices and domestic volume
growth.
Portfolio and Performance
Returns across KYN’s three
energy infrastructure sectors – midstream, U.S. utilities, and renewable infrastructure – were down in sympathy with the broad
financial market during the first fiscal quarter of 2023. U.S. utilities had a particularly volatile quarter with a sharp move to the
downside as interest rates rose, returning negative 8.3% during fiscal Q1. As interest rates and equities declined amid a volatile March,
utility stock prices behaved more defensively (total return of 5% in March).
Comparison of Returns in Fiscal Q1 2023
KYN Net Asset Return(2) | |
| -3.4 | % |
KYN Benchmark(4) | |
| -5.2 | % |
Midstream(6)(7) | |
| -5.2 | % |
Renewable Infrastructure(8) | |
| -2.5 | % |
U.S. Utilities(9) | |
| -8.3 | % |
KYN generated a total Net Asset
Return of negative 3.4% in fiscal Q1. While we are disappointed in the absolute return, we are pleased with performance relative to the
KYN Benchmark (180 bps outperformance) following 820 bps of outperformance in fiscal 2022.(3) KYN has now outperformed its
benchmark every quarter since the benchmark’s introduction in fiscal Q1 2021.
Endnotes can be found on page 5.
KYN’s Market Return, which is based on stock price performance rather than Net Asset Value, was 0.7% for fiscal Q1.(10) This exceeded
our Net Asset Return as our stock price traded at a 11.4% discount to NAV as of February 28th compared to a 15.0% discount at the beginning
of the fiscal year.
Our outlook at the start of fiscal 2023 was cautious and the events thus far this year, including volatility in the
banking sector, have reinforced this view. That said, we were optimistic about the outlook for the second half of 2023; recent events
have probably delayed when we “turn the corner” economically but have not fundamentally changed our expectation for a relatively
brief economic downturn.
It is our belief that North American energy
infrastructure businesses – many of which continue to generate significant free cash flow (and are thereby able to self-fund capital
expenditures and dividends) – are more insulated from the credit market volatility plaguing other sectors. Our bias is to remain
conservative with respect to fund leverage and to focus the portfolio on core North American-focused energy infrastructure names. We
believe that fundamentals for energy infrastructure, and particularly for midstream, remain strong despite the recent stock price pullback.
February 28, 2023 |
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Distribution & Outlook
Given KYN’s strong performance
during fiscal 2022 and our outlook for the next 12 to 18 months, we recently announced a 5% increase in our quarterly distribution (to
$0.21 per share). Further, we intend to recommend an additional one cent per share increase in KYN’s quarterly distribution rate
(to $0.22 per share, representing a cumulative 10% increase) once the combination with KMF is completed.
We believe these levels are sustainable
based on our long-term outlook for income we receive from our investments as well as capital appreciation in the portfolio. Of note, companies
in our midstream portfolio are trending towards “floor” leverage levels (and some have already achieved these targets). As
this occurs, we believe these companies are much more likely to use their “excess” free cash flow to increase quarterly dividends
or for stock buyback programs. Both actions are expected to be accretive to KYN’s returns. Our goal is to steadily increase KYN’s
distribution over time, as supported by the Company’s operating results.
Endnotes can be found on
page 5.
KYN & KMF Proposed Merger
We are pleased to announce the proposed
combination of KYN and KMF and firmly believe this merger enhances KYN’s ability to capitalize on the long-term tailwinds in the
energy infrastructure sector. Stockholders in the combined entity will continue to have exposure to the largest macro trends in the energy
industry, and the fund will be managed by the same dedicated team of professionals committed to providing attractive risk-adjusted returns
and best-in-class financial disclosure.
Based on each fund’s portfolios
as of February 28th, KYN’s pro forma portfolio would have been ~80% midstream and ~20% renewable infrastructure/utilities.
We believe that portfolio mix is a good “rule of thumb” for KYN once the merger closes – the substantial majority of
KYN’s portfolio will be allocated to midstream companies. While we are bullish on the midstream sector’s outlook, there is
little doubt in our minds that renewable infrastructure and utilities serve an important role in KYN’s portfolio as well. Importantly,
KYN’s investment mandate (1) provides flexibility for the combined entity to invest across a full spectrum of companies in the energy
infrastructure industry and (2) dynamically shift portfolio allocations among the different industry subsectors in an effort to generate
attractive risk-adjusted returns for stockholders.
KYN’s investment objective
and focus remain unchanged following this unanimously board-approved merger: We will continue to seek to provide a high after-tax total
return with an emphasis on making cash distributions to stockholders. We appreciate your feedback on the transaction to date, and we always
welcome commentary from our stockholders. KYN and KMF expect to mail a definitive joint proxy statement/prospectus to stockholders that
will contain additional information about the merger following a review period with the SEC.
KYN’s stockholder
meeting is scheduled to take place on June 20, 2023, and we anticipate closing the merger prior to the end of fiscal 2023. Please refer
to kaynefunds.com/insights for information on the combination.
We encourage investors
to visit our website at kaynefunds.com for more information about the Company, including the commentary
posted on the “Insights” page that discuss performance, key industry trends, and the proposed fund combination. We appreciate
your investment in KYN and look forward to providing future updates.
Endnotes can be found on page 5.
KA Fund Advisors, LLC
| (1) | More information on the merger is available in the preliminary joint proxy statement/prospectus
(Form N-14) filed with the Securities and Exchange Commission (SEC). KYN and KMF expect to mail a definitive joint proxy statement/prospectus
to stockholders that will contain information about the merger following a review period with the SEC. The definitive joint proxy statement,
along with other relevant documents, will be available at no charge on the SEC website at www.SEC.gov. Please refer to kaynefunds.com/insights
for additional information on the combination. |
| (2) | Net Asset Return is defined as the change in net asset value per share plus cash
distributions paid during the period (assuming reinvestment through our dividend reinvestment plan). |
| (3) | Relative performance based on the difference between the Company’s Net Asset
Return and the total return of KYN’s Benchmark. |
| (4) | KYN’s Benchmark is a composite of energy infrastructure companies. For fiscal
2023, this composite is comprised of a 75% weighting to the midstream sector, a 12.5% weighting to the renewable infrastructure sector,
and a 12.5% weighting to the U.S. utility sector. The subsector allocations for this composite were established by Kayne Anderson at the
beginning of fiscal 2023 based on the estimated target subsector allocations of the Company’s assets over the intermediate term.
KYN’s portfolio holdings and/or subsector allocations may change at any time. |
| (5) | Downside cushion reflects the decrease in total asset value that could be sustained
while maintaining compliance with 1940 Act leverage levels and KYN’s financial covenants. |
| (6) | Whenever we reference “midstream companies”, the “midstream sector”
or the “midstream industry” it includes both traditional midstream companies and natural gas & LNG infrastructure companies.
Traditional midstream companies are defined as midstream companies that own and/or operate midstream assets related to crude oil, refined
products, natural gas liquids or water. Natural gas & LNG infrastructure companies are defined as midstream companies that primarily
own and/or operate midstream assets related to natural gas or liquefied natural gas. |
| (7) | The benchmark for the midstream sector is the Alerian Midstream Energy Index (AMNA). |
| (8) | The benchmark for the renewable infrastructure sector is a composite total return
of 31 domestic and international renewable infrastructure and utility companies (calculated on a market-cap weighted basis with individual
constituents capped at a 5% weighting). |
| (9) | The benchmark for the U.S. utility sector is the Utilities Select Sector SPDR Fund
(XLU), which is an exchange-traded fund (“ETF”) linked to the Utilities Select Sector Index (IXU), a subset of the S&P
500. |
| (10) | Market Return is defined as the change in share price plus cash distributions paid
during the period (assuming reinvestment through our dividend reinvestment program). |
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