INSIGHTS

On August 04, 2017

Master Limited Partnership (MLP) Closed-End Funds: Second Quarter 2017 Review and Outlook

Data quoted represents past performance, which 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 had negative total returns in the second quarter and underperformed the broader closed-end fund market. The group was weighed down by weak and volatile energy prices, most notably crude oil. Concerns persisted that increased U.S. drilling activity and rising inventories may undermine efforts by the Organization of Petroleum Exporting Countries (OPEC) to stabilize crude oil markets through production cuts, which sent the price of oil down over 10% during the quarter.

The oil price decline most notably affected midstream energy companies with a greater perceived sensitivity to falling oil prices. For MLPs, we believe those concerns were largely misplaced, however, as rising oil volumes are generally beneficial to midstream energy companies, as they often translate into improving cash flows that could be used to strengthen balance sheets and increase cash distributions.

In earnings announcements released in the quarter, MLPs generally provided modest guidance for the first half of 2017. However, many companies stated that they expect stronger conditions in the second half of 2017 and heading into 2018.

As a group, market prices for MLP closed-end funds fell less than their net asset values (NAVs) during the quarter. This resulted in the sector going from trading a discount of –1.2% to trading at a premium of 0.6%, a reversion closer to its historical average premium of 1.9%. The group ended the quarter with an average yield of 9.3% based on market price, which was among the highest yields of all closed-end fund categories.

Investment Outlook

We believe North American midstream energy companies are in a position to gain market share if oil prices remain above $40 a barrel, a level that seems to be supported by OPEC’s production cuts. In our view, North American energy producers have lower upfront investment costs and quicker ramp-up times that give them a considerable advantage over other production alternatives. This could help drive an ongoing recovery in throughput volumes for the midstream sector in general, potentially translating into improving cash flows and, eventually, a possible reacceleration of distribution growth. Additionally, we believe U.S. energy policy is supportive of continued growth in exports, as seen in recent statements from the U.S. administration that may potentially allow for liquefied natural gas (LNG) exports to China.

In our view, the rebalancing taking place in the oil markets will continue, but crude oil prices will likely remain volatile as the inventory normalization process unfolds. Ultimately, our oil rebalancing roadmap points to a more balanced market developing in the coming quarters, as global demand continues to improve and supply rationalization carries on. Over time, we believe midstream energy and MLP fundamentals should strengthen as commodity prices stabilize, which could lead to increased volumes, improving the supply/demand dynamics in favor of pipelines.

We believe that midstream energy continues to represent an attractive investment opportunity, and that MLP closed-end fund valuations are appealing, although there appears to be limited room for additional fund discount narrowing in the coming quarters. Nevertheless, MLP closed-end funds currently offer high income rates relative to stocks and bonds, which, coupled with potential price appreciation, represents what could be a compelling total return proposition, in our opinion.

CRN: 2017-0803-6080 R

Disclosures



Data represents past performance, which is no guarantee of future results

The views and opinions in the preceding commentary are as of the date of publication and are subject to change. There is no guarantee that any market forecast set forth in this presentation will be realized.  The preceding commentary does not reflect the performance of any fund or account managed or serviced by Cohen & Steers and there is no guarantee that investors will experience the type of performance reflected in this commentary. This material should not be relied upon as investment advice, does not constitute a recommendation to buy or sell a security or other investment and is not intended to predict or depict performance of any investment. This material represents an assessment of the market environment at a specific point in time, should not be relied upon as investment advice, is not intended to predict or depict performance of any investment and does not constitute a recommendation or an offer for a particular security. We consider the information in this presentation to be accurate, but we do not represent that it is complete or should be relied upon as the sole source of suitability for investment.

The preceding commentary is provided for informational purposes only. It is not an offer to buy or sell any product or service. Opinions in this piece are those of Cohen & Steers and are not necessarily that of AAM.

Risks of Investing in Closed-End Funds. Shares of many closed-end funds frequently trade at a discount from their net asset value. The funds are subject to stock market risk, which is the risk that stock prices overall will decline over short or long periods, adversely affecting the value of an investment in a fund.

Risks of Investing in MLP Securities. An investment in MLPs involves risks that differ from a similar investment in equity securities, such as common stock, of a corporation. Holders of equity securities issued by MLPs have the rights typically afforded to limited partners in a limited partnership. As compared to common shareholders of a corporation, holders of such equity securities have more limited control and limited rights to vote on matters affecting the partnership. There are certain tax risks associated with an investment in equity MLP units. Additionally, conflicts of interest may exist among common unit holders, subordinated unit holders and the general partner or managing member of an MLP; for example, a conflict may arise as a result of incentive distribution payments. MLPs are subject to significant regulation and may be adversely affected by changes in the regulatory environment, including the risk that an MLP could lose its tax status as a partnership. MLPs may trade less frequently than larger companies due to their smaller capitalizations, which may result in erratic price movement or difficulty in buying or selling. MLPs may have additional expenses, as some MLPs pay incentive distribution fees to their general partners. The value of MLPs depends largely on the MLPs being treated as partnerships for U.S. federal income tax purposes. If MLPs were subject to U.S. federal income taxation, distributions generally would be taxed as dividend income. As a result, after-tax returns could be reduced, which could cause a decline in the value of MLPs. If MLPs are unable to maintain partnership status because of tax law changes, the MLPs would be taxed as corporations and there could be a decrease in the value of the MLP securities.

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 Morningstar All Taxable ex-Foreign Equity Index measures the market-capitalization-weighted total return of taxable equity and fixed income closed-end funds; it excludes international, regional and country closed-end funds. Index returns update frequently and are subject to change.

The Standard & Poor’s 500 Index is an unmanaged index of 500 large-capitalization, publicly traded stocks representing a variety of industries.

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/commentaries-disclosures.

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