Income Growth Advisors’ MLP strategy has an outstanding performance record ranking among the top MLP managers in the country1. In the 15 1/2 years since inception, its composite return is 16.85%2 and has outperformed the S&P 500 by 12.14% annually.
Our MLP strategy has a growth tilt which explains the modest underperformance to our MLP benchmark in down markets, but solid outperformance in up markets and our 3.92% outperformance over 15.5 years.
Until 2009, our strategy favored the largest MLPs like Kinder Morgan and Enterprise Products. Since 2009, we have added more growth MLPs using the 2008 and 2015 bear markets to sell some of the bigger companies in tax efficient swaps into smaller growth MLPs.
Our largest account is over $5 million, has 10 positions and currently yields 8.4%. We have overweighted smaller growth MLPs with solid growth prospects due to their shale proximities, business models, and strategic advantages.
The primary attribute driving our 15.5 year 12.14% outperformance to the S&P 500 is the MLP sector itself. While our nearly 4% outperformance to our MLP benchmark is impressive, the MLP sector has outperformed the S&P 500 by 8.22% since 2000. This exceptional outperformance has been fueled by declining interest rates and the growth in shale. Looking ahead, we expect the benefit of declining rates will end, but that MLPs will continue to offer uniquely high yields. We also forecast that the growth rate in shale development will moderate to mid to low single digits rates from its double digit shale boom rates which preceded the 2014-5 oil crash. As a result, in the years ahead, MLP cash flow growth and distribution growth will continue to drive outperformance to other income alternatives like bonds and REITs, though at a more moderate rate.
We currently forecast a 22% MLP total return until year. (See page 18 of our attached presentation.) The key attribute driving this high return is the abnormally high MLP yield spreads to 10 year US Treasuries, high yield bonds and REITs. All three spreads show attractive yield differentials which should drive further investment flows due to the high yields that MLPs offer. With oil prices stabilizing and growing expectations of a balanced oil market in 2017, the risk profile of oil operations should decline and drive lower yields across the MLP sector.
The unique attribute that MLPs offer is that they operate energy assets in a corporate tax free environment. The Master Limited Partnership structure eliminates approximately a 30% earnings liability resulting in cash flows and distributable cash flows being approximately 30% higher than a similar energy business in a C-Corp structure. For this reason, the solid stable growing tax advantaged income streams characterize the unique investment appeal of MLPs.
We are a country obsessed with convenience. Consequently, it is no surprise the mutual funds, Exchange Traded Funds, and closed end funds house over $100 billion in MLP assets in a highly tax inefficient manner. The benefit of the MLP tax free structure is effectively wiped out by 1940 Investment Company Act structures (mutual funds and ETFs). The table below quantifies the significant performance differential between our separately managed account composite and the most prominent MLP ETF–the Alerian MLP ETF (AMLP).
The news is disconcerting with a rapid increase in terrorism and a US presidential election dividing an increasingly partisan populace with two candidates with record unfavorability ratings. Last week’s “Brexit” heightened fears widening yield spreads and making MLPs even more attractive. With the world’s economy being indecisive and anemic combined with equity and bond markets trading at rich valuation levels, MLPs are an investment where significant outperformance and income can be realized. For optimal performance, we advise that clients invest directly in MLPs through separately managed accounts. We use Interactive Brokers or US Trust to house our client accounts. This gives our clients online access to their accounts and the comfort of knowing what they own and that it is at a reputable custodian.
Happy Fourth of July!
Tyson Halsey, CFA