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On August 02, 2016
Master Limited Partnership Closed-End Fund Second Quarter 2016 Review and Outlook
Performance data quoted represents past performance. Past performance is no guarantee of future results.
(Q2=2nd quarter, YTD = Year to Date, NAV = Net Asset Value, MLP = Master Limited Partnership)
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 historicaland include change in share price and reinvestment of all distributions. An investor cannot invest directly in an index andindex performance does not reflect the deduction of any fees, expenses or taxes. See bottom 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 surged in the second quarter and were among the strongest performing groups within the closed-end fund universe. MLP closed-end funds rebounded from losses incurred in the first quarter, with the underlying securities taking their cue from crude oil prices, which jumped nearly 20% in the quarter. Crude oil rallied as a decline in production and strong demand shrank oversupplied conditions. Production declines in Canada, Nigeria, Venezuela and elsewhere brought the global oil surplus closer to balanced conditions. For midstream energy companies, the threat of counterparty risk, while still meaningful, eased as oil prices moved higher. Also favoring the funds were diminished concerns about MLP distribution cuts.
U.S. economic data was mixed, with the housing sector and consumer spending notable bright spots. At the end of the quarter, the U.K. voted to end its membership in the European Union (EU), in contrast to widespread expectations. The decision triggered the resignation of Prime Minister David Cameron, who called for the referendum and supported staying in the EU. The so-called “Brexit” news spurred a sharp selloff in global equity markets and a rally in assets perceived to be safe, including gold, as investors weighed its global economic ramifications. Markets bounced back in the week following Brexit as the initial shock wore off.
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 (26.0%) increased in line with their NAVs (26.0%) in the quarter. Average discounts held steady at 2.7% at the end of the period. The group ended the quarter with an average yield of 9.6% based on market price, down from 11.8% at the start of the quarter.
Investment Outlook
We believe the long-term case for MLPs remains attractive, and that we are in the bottoming process of the commodity cycle. We believe midstream firms generate the strongest cash flow growth during periods highlighted by:
1. High, stable commodity prices;
2. Rising domestic energy production, and
3. Capacity constraints and infrastructure bottlenecks.
While crude oil prices could rise modestly in coming months, declining throughput volumes and excess pipeline capacity may weigh on midstream asset performance in the near term. However, we expect North America to gain market share in the global energy supply chain, which should lead to increasing volumes and tightening capacity over the longer term.
With regard to MLP closed-end funds, we believe valuations remain compelling.
Index Definitions
The Alerian MLP Index is a float-adjusted market-capitalization-weighted index that consists of the 50 most prominent large- and mid-cap energy master limited partnerships.
The Barclays Capital U.S. Aggregate Bond Index is a broad-market measure of the U.S. dollar-denominated investment grade fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, mortgage-backed securities, asset-backed securities, and commercial mortgage-backed securities.
The Standard & Poor’s 500 Index is an unmanaged index of 500 large-capitalization, publicly traded stocks representing a variety of industries.
CRN: 2016-0802-5489 R
Opinions in this piece are those of Cohen & Steers and are not necessarily that of AAM.
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. For additional commentary or financial resources, please visit www.aamlive.com.
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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