Income Growth Advisors, LLC MLP Separately Managed Account (SMA) performance declined 2.80% in October, beating our MLP benchmark index, the Alerian (AMZX), which declined 4.45%. Year to date we continue to produce strong performance with returns up 28.23% on a size weighted basis and 66.58% on an equal weighted basis. While we expect a moderation in our recent return trajectory, we believe that our MLP strategy could produce total returns on the order of 50% over the next two years.
October’s monthly and year to date returns:
Equal weighted performance is displayed as average return.
October’s returns were bolstered by the merger announcement between American Midstream Partners, LP (AMID) and JP Energy Partners, LP (JPEP), two of our largest holdings. Both of these small growth MLPs were particularly attractive to us due to their relationship to ArcLight Capital Partners, LLC an energy private equity firm with over $16 billion invested. We believe this strong private equity partner will allow for a healthy flow of assets and financial support, which initially led to our investing in these top performing MLPs. Before the October 24th merger announcement, AMID and JPEP were up 84.7% and 53.2% year to date.
The merger of these two high yielding MLPs form a larger more diversified MLP that is more likely to attract institutional fund flows. The combined market capitalization will be about $2 billion. JPEP’s weak distribution coverage will now be supplemented by AMID’s 170% distribution coverage. The new combined AMID will be positioned to pick up larger dropdowns from ArcLight Capital Partners, LLC. JPEP is well positioned to benefit from improving production from the Permian Basin, the West Texas shale with the most attractive shale oil economics in the United States. AMID has excellent Gulf of Mexico natural gas properties offering a solid growth trajectory. These two growth businesses now combine to lower the risk profile for the merged entity.
We anticipate 100-150% appreciation for the combined AMID entity over the next two to three years. This is based on the proforma distribution growth guidance of 5% in 2017-18 and 15% growth afterwards. AMID currently yields 11.7%. We believe that as this merger goes through and the distribution growth is reflected in the AMID distribution guidance, AMIDs yield will drop to 6% through unit price appreciation of approximately 100%. As the company continues to grow, and its distribution growth ramps to 15%, AMID could appreciate even further as its distribution yield increasingly trades in line with other growth MLPs.
Due to the issue of potential concentration, we expect to slowly scale out of the position to keep the position concentration reasonable while seeking to benefit from the appreciation we foresee for this new growth MLP. In today’s low interest rate environment, a growing high yielding MLP will be an attractive investment.
We are confident in our stock picking ability. We have been focusing on MLPs whose specific business models are particularly well positioned to outperform in this lower oil price environment. In addition to AMID and JPEP, we continue to favor companies whose businesses point to solid growth prospects. Another growth MLP we have been accumulating is Teekay Offshore Partners, LP (TOO). Teekay’s oil services shipping fleet are benefitting from a recovery in offshore drilling, particularly, in the faster cycle, lower cost, shallow water projects. The competitive advantages these MLPs hold should lead to solid outperformance over the next two to three years.
For optimal performance, we recommend investing in MLPs through separately managed accounts and avoiding MLP mutual fund structures. MLP mutual funds are subject to taxation of approximately 30% defeating the benefit of the tax free MLP corporate structure. This outperformance is illustrated below. IGA’s MLP Separately Managed Accounts have outperformed the AMLP Exchange Traded Fund by 12.05% annually. 12.05% (= 13.31% – 1.26%) before management fee and since inception 8/31/2010.
For the convenience of avoiding K-1s, this performance disparity is considerable. Consequently, for investments in excess of $100,000, we recommend our separately managed account strategy. We offer this strategy through our prime brokers US Trust/Bank America/Merrill Lynch and Interactive Brokers. We believe this is a particularly sensible time to evaluate your allocation to this attractive sector – the yield spreads over other yield vehicles are still abnormally high and normalcy is returning to the oil market. We see a clear path to generating meaningful relative and absolute performance over the next two years.
Tyson Halsey, CFA
Income Growth Advisors, LLC
225 Seven Farms Drive, Suite 108
Charleston, SC 29492