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In Pursuit of Value
MLP Update Master Limited Partnerships (MLPs) are attractive income generating investments that belong in most taxable portfolios for those clients willing to deal with K-1s for tax filing as opposed to 1099s. Current distribution yields are above 6% and typically most of those distributions are characterized as a return of capital for the investor, resulting in a deferral of the income tax liability on that income. MLPs have generated a total return of 15% p.a. since 1996 according to the Alerian MLP Index (AMZX). The combination of attractive distribution yields and steady distribution growth linked in many cases to PPI creates an attractive risk-return profile. MLPs are equity interests and can suffer sharp moves as happened for example in 2008 when retail investors and hedge funds were aggressive sellers. However, the businesses are far more stable than their equity price moves might suggest, and a diversified portfolio owned without leverage can provide a useful source of income.
450 400 350 300 250 200 150 100 50 0 Dec-95 Feb-97 Apr-98 Jun-99 Aug-00 Oct-01 Dec-02 Feb-04 Apr-05 Jun-06 Aug-07 Oct-08 Dec-09 Feb-11 Apr-12 1.5
Alerian MLP Index 1996-2012
SL Advisors, LLC is a registered investment advisor offering separately managed accounts to individuals, family offices and institutions.
So far this year the performance of MLPs has been relatively poor. Following a strong 14% return in the AMZX last year, weak demand has caused the sector to lag both stocks and bonds through 1H2012. YTD performance for MLPs is -0.4% compared with +9.5% for the S&P 500 and +5.7% for the Dow Jones Corporate Bond Index. However, MLP fundamentals haven’t weakened, and the result is that lower prices combined with continued distribution growth have pushed MLP yields higher to attractive levels compared with corporate bonds. The chart below shows the current yield on the Alerian Index (6.6%) and highlights that it’s currently 1.6% above corporate bonds (defined as the Moody’s Baa seasoned bond index, equivalent to S&P BBB, as published by the Federal 14 MLP Yield (LHS) Reserve). This is back to the 3.5 12 widest levels seen since the Credit MLP vs Corp Sprd 2.5 Crisis. 10
The weaker growth outlook and the consequent drop in oil prices 0.5 have hurt sentiment, although 4 midstream MLPs (which is the -0.5 sector we focus on) have little 2 direct exposure to commodity -1.5 0 prices. They are sensitive to the volumes of oil and natural gas that they store, move and refine and to the extent that a weak economy hurts volumes that can show up in financial results. But volumes are not substantially different, and many MLPs are likely to increase their distributions by 5-6% or more. Combined with current yields of 6.5% this creates a potential one year return of 11.5-12.5% assuming no change in yields.
6 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12
S. Our Deep Value Equity Strategy remains largely invested with around 5-6% of cash available if certain target companies become more attractively priced. including exchange traded funds (ETFs). In summary. including the slow trainwreck that is Eurozone efforts to save the common currency through austerity and unclear U. the most appropriate asset allocation is to minimize fixed income exposure in favor of a barbell using equities and cash. . LLC focuses on identifying securities that are trading at a discount to intrinsic value. The Buttonwood column featured my book back in January. 2013 “fiscal cliff” of sharp spending cuts and tax hikes based on current law. with Lipper reporting $19.Tax reform is a potential concern. We think MLPs and our Hedged Dividend Capture Strategy are far better in terms of income generation. although the relentless Math as described above will inevitably lead to declining and ultimately negative returns from this strategy. $22 of the proceeds invested in the S&P500 (yield 1. fiscal policy including the January 1. Our biggest thematic bet remains natural gas E&P names. Quarterly Outlook The economic outlook moderated during the quarter. U. we think an adverse outcome is unlikely since the National Association of Publicly Traded Partnerships (NAPTP) is an effective lobbying group and the tax benefits largely accrue to passive investors. Our overall view remains that conventional fixed income represents an exceptionally poor investment. MLP valuation is relatively attractive compared to corporate bonds. If I could read only one weekly magazine (or newspaper since that is how they refer to themselves) this would be it. Nonetheless. In recent years a substantial number of MLP funds have been launched. but should wholesale tax reform receive serious consideration following the election MLPs might suffer through the uncertainty. A portfolio of direct holdings of MLPs is the most tax-efficient way to invest.S. Substantial macro concerns continue to weigh on the market. The outlook often appears worse from a top-down perspective than it does when analyzing individual companies. the conversion of K-1s to a 1099 comes at a considerable cost in terms of additional taxes. The Economist Book Review I was very happy to see that The Economist reviewed The Hedge Fund Mirage this weekend. that is clearly the case today. and valuations became somewhat more attractive. and while they can make sense for a retail investor with perhaps $100K to invest. Meanwhile the hedge fund industry continues to support the ideas in my book by delivering mediocre results at great expense.9%) and 4% dividend growth with unchanged dividend yields will cause the equity investment to generate the same after tax return as the bonds. mutual fund investors continue to build their holdings in bonds. The Equity Risk Premium (S&P500 Earnings Yield less 10 Year Treasury Yield) remains over 6%. Government bond yields are negative in real terms and corporate bonds are scarcely better once taxes are figured in. However. The thinking behind this and our other investments can be found regularly updated on our blog. a level last seen in the early 1970s. exchange traded notes (ETNs) and closed end funds.6% yielding ten year treasuries could be sold.9BN of net inflows in June (compared with $3BN in redemptions from equity and “mixed asset” mutual funds). public policy remains one of transferring real wealth from savers to borrowers. while keeping $78 in cash. $100 of 1. Retail investors are buying what’s worked. Such is my regard for the quality of their journalism that I would unquestioningly accept their views about my book. and the thoroughness of the journalist on that story (whose research included reviewing the spreadsheets I had analyzing hedge fund returns) speaks well of the rigor with which they go about their work. SL Advisors. None of them preserve the tax characteristics of the underlying investments. happily they found much to like. This illustrates how poor an investment bonds are. Prior unsuccessful Congressional attempts at taxing carried interest have not included MLPs.
3 6.2 4.9 Aug 0.5 0.1 Oct -1.4 -2.0 -4.6 1.1 2.4 3.7 1.9 2.8 -4.3 0.6 -2.8 12.5 0. YTD returns are unannualized compounded returns.1 0.2 -0.2 Dec 9.2 0.7 -3.3 -1.7 1.2 35.4 -1.7 1.2 3.2 0.6 0.2 -7.0 6.1 6.0 2.4 1.4 Sept 11.9 Nov 3.8 3.9 -2.2 0.2 Dec 7.4 -0.6 3.5 2.8 -3.2 0. The Index is the S&P 500 including dividends.6 1.6 -3.9 1.0 3.3 2.0 1. Past performance is not indicative of future returns.9 Feb 3.2 Oct 2.5 1.9 -0.4 9.0 0.5 -0.1 -8.6 3.1 -3.3 1.3 -0.1 3.3 3.7 1.9 0.3 3.2 1.2 April 1.0 5.7 -0.3 0.0 4.1 -2.4 0.6 1.5 July 3.4 37.4 4. until October 2011.5 Sept 0. Past performance is not indicative of future returns.0 April 1.0 -1.5 Returns for each strategy shown at right are from a single continuously managed account and have been independently verified and attested to by Marcum.0 -4.0 6.5 -0.2 4.1 10.5 -3.0 1.2 1.3 -2.9 2. Contact us for more information.5 1.4 Returns do not include cash balances prior to May 2010. Returns are net of fees.1 -0.1 2.3 1.7 2.3 -1. The Index is the HFRX Equity Market Neutral Index.com 2010 Index 2011 Index 2012 Index Returns through September 2011 are from a long portfolio of 58 equally weighted equities from which actual positions are selected.6 -1.7 2.8 -04 -3.5 -5.4 2.2 0.1 5.6 1.7 -4.1 -7.0 1.9 -5. AMZX.9 -1.9 2.4 0.4 0.1 Sept -14.3 76.9 3.2 -1.1 -1.7 6.7 1.1 -1.3 3.1 3.3 -1.3 -1.3 -0.3 0. 2012 Index Returns do not include cash balances prior to November 2009. This is not a return from an actual portfolio.3 1.2 1.2 15.6 2.2 2.2 1.2 -0.5 3.2 -0.1 3. LLP.2 6.5 -0.9 0.4 June 1.4 3.6 15.2 1.5 5.4 Feb 0.6 -1.8 5.1 0.2 -0.0 0.8 -0.2 3.2 3.9 -0.8 -2.8 3.5 2.2 1.1 -1.0 -0.6 0.5 0.1 -2.3 5.3 0.1 -1.9 1.7 1.8 -6.9 0.3 10.7 -0.2 1.2 5.0 Oct 0.4 4. MLP Strategy Monthly Returns (%) Jan 2008 Index 2009 Index 2010 Index 2011 Index 2012 Index -0.9 -1.9 0.2 YTD 15.0 -2.4 -0. Returns are net of fees.3 2.5 -2.1 -3.6 1.0 1.8 1.1 1.1 -0.7 -0.0 0.2 -0.1 0.0 2.9 0.8 3.1 0.5 May 1.9 2.6 Nov 0.9 -0.1 2.0 0.6 6.6 2.0 -7.0 -0.5 6.7 0.6 7.3 -0.8 11.4 4.8 -0.3 0.9 -17.4 0.9 15.8 -0.3 -5.8 4.7 6.1 2.9 2.0 -2.sladvisors.9 73.2 -1.6 -2.5 1.7 -4.2 0.5 3.2 Mar -0.7 0.6 0.6 -2.6 -8.3 0.6 5.7 2.0 -0.0 SL Advisors runs a variety of separate strategies in Fixed Income.4 -4.0 -4.8 1.0 YTD 39.0 -0.1 12.1 1.1 -3. Deep Value Strategy Monthly Returns (%) Jan 2009 Index 2010 Index 2011 Index -1.2 7.4 -4.5 -0. Equities and Absolute Return.0 3.1 -4.7 0.4 -1.6 15.4 1.6 2.5 0.3 -5.8 Mar -1.4 1.6 5.2 -0.8 5.7 10.3 5. The Index is the Alerian MLP Index.3 -0.1 9.4 5.5 0.9 7.3 2.2 -2.1 Feb Mar April May June July 8.7 5.1 5.2 1.6 30.4 2.5 -0.8 1.9 -0.1 3.9 9.Hedged Dividend Capture Strategy (%) Jan 2006 Index 2007 Index 2008 Index 2009 Index 0.8 8.0 1.3 Nov -25.3 22.4 5.5 -5.5 -0.3 July -2.1 0.0 2.8 YTD -36.0 0.6 0.6 -0.8 7.8 -0.5 -1. or go to our website: www.7 -0.8 -6.9 0.5 7.9 -2.6 0.3 1.0 -0.2 -1.5 -5.3 0.2 -5.5 -1. Documentation available on request.1 -36.9 -1.2 May 4.0 4.0 9.1 -0.4 -17.1 7.4 0.4 -3.6 -1.0 Aug 1.4 -2.9 -0.6 1.2 Dec 1.1 -0.0 -0.6 -5.8 8.0 4.6 2. Returns are net of fees.5 1.6 -1. .5 -4.5 Aug 1.2 1. Past performance is not indicative of future returns.9 -9. hedged to be beta neutral.0 -1.7 7.4 3.9 -1.7 5.5 1.7 3.7 0.0 2.2 3.4 15.8 2.8 13.5 June -10.0 -1.1 2.
markets change and SL Advisors. Historically this strategy has exhibited monthly swings comparable to corporate bonds. Companies are selected that possess a history of steady earnings growth. Desired characteristics of businesses include pricing power. the largest provider of custody services in the U. They represent direct proportional ownership stakes in the underlying assets rather than securities in a corporation. and attractive valuation.SL Advisors offers separately managed accounts for individuals.S. as a whole or in part. and is also appropriate as an alpha seeking equity strategy for institutional accounts. SL Advisors Deep Value Equity Strategy A portfolio of undervalued stocks of high quality businesses that aims to outperform the S&P500. LLC will seek to capitalize on attractive opportunities wherever they might be.S.S. equities trading significantly below the intrinsic value of the underlying enterprise. with assets of $1.com DISCLOSURES: This document is not an offer to sell (or solicitation of an offer to buy) securities in the United States or in any other jurisdiction. Historically they have paid regular distributions which have grown with the U. Potential investments are identified both qualitatively and quantitatively following which detailed research is performed to assess fundamental value. my new book. In Pursuit of Value. This strategy is part of the equity allocation for balanced accounts for individuals.com Our blog.sl-advisors. Depending on conditions and trends in securities markets and the economy generally. and as such they can be suitable for investors seeking income generating investments with a tolerance for equity market exposure. LLC. Client portfolios are completely transparent via Schwab’s extensive website which provides real-time access to accounts and all supporting information. LLC 210 Elmer Street Westfield. Click on the image to read more. Any reproduction or distribution of this document. The Hedge Fund Mirage. without the prior written consent of SL Advisors. economy. SL Advisors MLP Strategy This portfolio consists of 10-15 investments in Master Limited Partnerships (MLPs) to receive a healthy and growing tax deferred income stream.36 trillion and 7.hedgefundmirage.com/author/sl-advisors. Go to: http://www. family offices and institutions across various investment strategies. attractive dividend yields and are less volatile than the overall market. LLC is not limited with respect to the types of investment strategies it may employ or the markets or instruments in which it may invest (subject to any contractual arrangements and/or applicable law).com www. Investments are in listed U. The long positions are hedged with a short S&P500 position with the objective of making the portfolio beta neutral while still maintaining a net long equity exposure. is at: http://blog. LLC may pursue other objectives or employ other techniques it considers appropriate and in the best interest of its clients (subject to any contractual arrangements and/or applicable law). The portfolio is reassessed constantly and all holdings are rated for return potential and risk against their peer group to rebalance into the most attractive opportunities. SL Advisors Hedged Dividend Capture Strategy An alternative to bonds. or go to http://seekingalpha. NJ 070902128 908-232-0830 sl@sl-advisors. The strategy engages in low turnover so as to minimize transaction costs and benefit from the income tax deferral features of the asset class. readers should understand that SL Advisors. This strategy may be considered as a substitute for a portion of an investor’s fixed income allocation. low leverage. Client assets are held with Charles Schwab. SL Advisors does not provide tax advice.9 million individual accounts (as of June 30. 2010).com SL Advisors regularly publishes investment research on Seeking Alpha's website. . equities. MLPs are publicly traded interests in energy infrastructure and related assets. Detailed monthly statements are mailed directly to clients from Schwab. low costs of production. MLPs are appropriate for high net worth investors comfortable with receiving a K-1 for each investment rather than a 1099. then relatively using peer multiples and finally liquidation value. unleveraged.sladvisors. is now available. this strategy utilizes stocks of stable companies with high dividend yields to generate income with capital appreciation by investing in a diverse. or the disclosure of the contents hereof.S. is prohibited. Over time. Contact info: SL Advisors. hedged portfolio of U. and given the relative attractiveness of equities compared with investment grade bonds it has a more attractive return outlook. Valuation is defined to us foremost as the net present value of cash one can extract from proportional ownership of the business. Notwithstanding the general objectives and goals described in this document. SL Advisors.
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