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Financial Industry Insights from Advisors Asset Management
On April 21, 2016
Master Limited Partnership (MLP) Closed-End Fund First Quarter 2016 Review and Outlook
Performance data quoted represents past performance. Past performance is no guarantee of future results. The rate of return will vary and the principal value of an investment will fluctuate and shares, if sold, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data quoted. Returns are historical and include change in share price and reinvestment of all distributions. An investor cannot invest directly in an index and index performance does not reflect the deduction of any fees, expenses or taxes. See back page for index definitions. *Closed-end fund total returns are based on market price. (1) Return based on net asset value (NAV). (2) Represents performance of the MLP sector of the Morningstar U.S. All Taxable ex-Foreign Equity Closed-End Fund Index. (3) Represents the Morningstar U.S. All Taxable ex-Foreign Equity Closed-End Fund Index.
Investment Review
Master limited partnership (MLP) closed-end funds declined in the first quarter, but losses were curbed significantly by a rally during the second half of the period. The underlying MLP securities—which remained under pressure for a third-consecutive quarter—took their cue from crude oil prices, which hit a 13-year low in February amid stubbornly high supply and heightened concerns about global economic growth.
Crude oil rallied on upbeat economic data and speculation that the Organization of Petroleum Exporting Countries (OPEC) may agree on an output freeze in light of oversupplied markets. Accommodative global central bank policies—including additional monetary stimulus from the European Central Bank and more dovish posturing by the Federal Reserve—also lifted investor sentiment during the second half of the quarter. Crude oil rallied more than 40% from its February low, ending the quarter up 3.5%.
While most midstream energy businesses have little direct commodity exposure, the stabilization in oil prices eased concerns about the sector’s liquidity and company access to capital. Given the encouraging economic data in the second half of the quarter and aggressive capital expenditure cuts by U.S. shale producers, investors grew more confident that the oil market will ultimately balance and the fundamental outlook for MLPs will improve.
MLPs that focused on strengthening their balance sheets generally performed the best during the quarter. Nevertheless, there were also a number of instances in which companies with riskier balance sheets bounced back from deeply oversold levels.
The MLP closed-end funds’ market prices (–4.5%) declined considerably less than their NAVs (Net Asset Value) (–7.1%) in the quarter. Average discounts narrowed substantially, from 5.9% to 2.7% at the end of the period – significantly undervalued relative to their 10 year average premium of 2.4%. The group ended the quarter with an average yield of 11.8% based on market price, the highest among all closed-end fund categories. However, additional distribution cuts are possible if energy prices remain low in the coming months.
Investment Outlook
We believe crude oil markets are likely to see improving fundamentals. Following massive capital expenditure reductions from exploration & production companies, we believe valuations remain compelling and continue to have a high conviction for MLPs over the intermediate and long term. However we remain cautious on the sector in the near term given the likelihood of weak throughput volumes, which may negatively impact cash flows and balance sheets.
CRN: 2016-0420-5289R
Opinions in this piece are those of Cohen & Steers and are not necessarily that of AAM. All investments are subject to risk and past performance is no guarantee of future results.
This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information athttps://www.aamlive.com/legal/commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.
Performance data quoted represents past performance. Past performance is no guarantee of future results.
The views and opinions in the preceding commentary are as of 3/31/2016 and are subject to change. There is no guarantee that any market forecast set forth in this presentation will be realized.
This commentary is provided for informational purposes only. It is not an offer to buy or sell any product or service.
Closed-End Funds Investment: Risks include higher interest rates, economic recession, deterioration of the bond and equity market, possible downgrades, early call provisions, changes to the tax status of the bonds and defaults of interest and/or principal. Shares of closed-end funds are also subject to various risks, including management’s ability to meet the fund’s investment objective, and to manage the fund’s portfolio when securities are redeemed or sold, during periods of market turmoil and as investor perceptions regarding the funds or their underlying investments change. In addition, closed-end funds frequently trade at a discount to their net asset value in the secondary market.
Master Limited Partnerships (MLPs): MLPs are generally taxed as partnership whose interest are generally traded on a securities exchange. Most MLPs generally operate in the energy natural resources or real estate sector and are subject to the risks generally applicable to companies in those sectors. Those risks include, but are not limited to, commodity pricing risk, supply and demand risk, depletion risk and exploration risk. MLPs are also subject to the risk that authorities could challenge tax treatment of MLPs for federal income tax purposes which could have a negative impact on the after-tax income available for distribution by the MLPs and/or the value of the trust’s investments.
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