Wall Street’s MLP Fund Frenzy
Investors can now choose from 47 fund products–22 closed-end funds, 13 exchange-traded products and 12 mutual funds–that focus exclusively on, or allocate significant amounts of capital to, master limited partnerships (MLP).
Thirty-five of these MLP-focused offerings have launched since 2010, with 11 new closed-end funds, 12 mutual funds, eight exchange-traded notes (ETN) and four exchange-traded funds (ETF) hitting the market.
That’s a high level of institutionalization for a universe of energy-related MLPs that swelled to 82 names after the recent initial public offerings of Susser Petroleum Partners LP (NYSE: SUSP) and Summit Midstream Partners LP (NYSE: SMLP).
The proliferation of fund products that provide targeted exposure to energy-related MLPs in part reflects the fundamentals and market conditions that make these securities appealing to investors.
The above-average yields offered by MLPs have found favor with investors at a time when traditional income-generating securities such as corporate bonds and real estate investment trusts (REIT) appear overbought and offer relatively paltry yields.
But you shouldn’t assume that the prevalence and growing popularity of these investment vehicles mean that they’re worthwhile holdings; the fee income that asset management from closed-end funds and exchange-traded products is considerable.
Investors’ search for more yield is one of the reasons that UBS (Zurich: UBSN, NYSE: UBS) has launched a suite of six ETNs that focus on MLPs.
Brian Hull, vice chairman and group managing director of UBS Wealth Management Americas, acknowledged as much in his presentation at the recent Bank of America Merrill Lynch Banking and Insurance CEO Conference: “We’ve seen some improvement in some of the activity, especially in things that have yield. So if you looked at the closed-end fund market, if you looked at the MLP market, at REITs, at preferreds, we’ve seen clients respond to that ability to lock in more attractive yields.”
Piper Jaffray (NYSE: PJC), a Minneapolis-based investment bank and asset management firm, has also sought to give the public one-stop exposure to the MLP space–and rake in fees along the way. Management has identified its FAMCO MLP & Energy Income (INFRX) and FAMCO MLP & Energy Infrastructure (MLPPX) mutual funds as key sources of organic growth in coming years.
At the Sandler O’Neill Global Exchange and Brokerage Conference, CEO Andrew Scott Duff described these products as a critical component of the firm’s ongoing efforts to “remix” its business to emphasize higher-margin, higher-return opportunities. Duff also noted that “these high-performing MLP products with an attractive yield” are “where net assets [have been] going from a retail perspective and an institutional perspective for the last couple of years.”
Batimore-based asset management company Legg Mason (NYSE: LM), which on June 27 rolled out its third MLP-focused closed-end fund, ClearBridge Energy MLP Total Return (NYSE: CTR), is also bullish on funds that specialize in this security class.
In a conference call to discuss results for the fiscal first quarter ended June 30, 2012, management highlighted the firm’s success in growing its closed-end business, citing the success of its MLP-focused products:
[O]ver the last four years, we have averaged 20% of all closed-end fund market issuances, advancing our leadership ranking. In particular, the closed-end fund structure has been a good one for the MLP market, which has had strong [demand among] equity investors seeking new sources of income; these are high fee, long-term assets.
Although much of the easy money in MLPs has been made in the wake of the financial crisis and market meltdown, asset managers and investment banks continue to rake in the fees by launching new investment products.
For example, Global X Funds, a New York-based provider of exchange traded funds, in August filed a prospectus with the Securities and Exchange Commission to launch Global X Junior MLP ETF, a product that would provide exposure to a basket of small-capitalization publicly traded partnerships.
But in the New Normal, stock selection and a focus on valuations will be essential to outperforming the broader market and the Alerian MLP Index.
Many MLP-focused funds offer exposure to the high-quality names that appear in MLP Profits’ model Portfolios, but investors should be aware that these investment vehicles invariably include marginal fare that detracts from overall performance.
Proponents of fund products often extol the risk-management benefits of having broad exposure to a specific asset class. But the “instant diversification” that blunts the impact if an individual stock tanks also dilutes these funds’ upside potential.
Recent results suggest that investors seeking sustainable yields and above-market returns should rely on a rifle (stock-picking) rather than a shotgun (a fund). Excluding fees, only 11 of the 47 MLP-focused funds currently on the market have outperformed the Alerian MLP Index’s 25.9 percent return over the past 12 months, while only two have outperformed this benchmark over the past three months.
Investors who own one of these funds and units of blue-chip names such as Enterprise Products Partners LP (NYSE: EPD), Kinder Morgan Energy Partners LP (NYSE: KMP) and Plains All American Pipeline LP (NYSE: PAA) should be forewarned that these stocks also figure prominently in many fund portfolios. The investable universe of MLPs is small relative to other sectors and industry groups, which means that many of these fund offerings–for all their claims of pursuing a unique strategy–in reality have similar portfolios.
The funds pushed by the various investment houses eliminate some of the headaches with figuring out tax liabilities on individual MLPs–investors receive a single Form 1099 rather than a slew of Form K-1s. But many of these funds expose investors to the double taxation that individual holdings avoid.
Around the Portfolios
Linn Energy LLC (NSDQ: LINE) updated its third-quarter guidance today. Management estimated the midpoint of the firm’s adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) at $380 million. The limited liability company also forecast that third-quarter production would come in between 760 and 780 million cubic feet of natural gas equivalent per day. These expectations prompted management to raise its estimate of full-year adjusted EBITDA to $1.365 billion from $1.35 billion, an incremental increase that would translate into a distribution coverage ratio of about 1.1 times cash flow.
The firm also disclosed details about its horizontal drilling program in the Hogshooter, an oil-bearing formation in the same vicinity as the Granite Wash. During the third quarter, Linn Energy drilled nine Hogshooter wells that yielded an average initial production rate of 1,983 barrels of oil per day, 534 barrels of natural gas liquids per day and 3.4 million cubic feet of natural gas per day. These results were in line with previous wells drilled in the play. We continue to rate Linn Energy LLC a buy when the stock dips to less than $40 per unit.