MLPs = Good Returns in All Markets: Darren Schuringa
Tue, May 22, 2012
With interest rate yields so low, it’s not surprising that more investors are flocking to the excellent income and relative downside stability afforded by Master Limited Partnerships and related ETFs. In this exclusive interview with The Energy Report, Darren Schuringa, portfolio manager at Yorkville Capital Management, tells us about MLP sector performance and explains why this arena provides an excellent balance of income and upside potential in a variety of market environments.
The Energy Report: Master Limited Partnerships (MLPs) have really grown in the past few years. Why is that?
Darren Schuringa: MLPs’ growth is really two fold. First, the sheer number of partnerships doing initial public offerings has accelerated. In 2000 there were 27 MLPs, and today there are 85 listed. The second half of the growth story is simply strong performance. The total returns of MLPs over the past five years have averaged 14.2% relative to the S&P 500, which has been flat to slightly down over that same period. MLPs also have an appealing structure: They are pass-through vehicles that don’t pay corporate income taxes. They offer a tremendous cost of capital advantage in that you’re saving 35% on taxes.
Since the Tax Reform Act of 1986, when MLPs were created by an act of Congress, there has been a compounded annual growth rate in the overall market capitalization of the asset class by 13%. Over the past decade, this growth accelerated to 25% per annum. So, the MLP growth is certainly not plateauing; it’s accelerating. The Marcellus and the Bakken shale play infrastructure needs will only accelerate, which bodes well for MLPs.
TER: Didn’t these start out as tax shelters that weren’t tradable and then evolved into tradable partnerships?
DS: Correct. That has been the evolution of the asset class. You can still find private partnerships to invest in, but we are just focusing on the partnerships that trade like regular equities.
TER: Yorkville Capital Management is a member of The National Association of Publicly Traded Partnerships (NAPTP), which is holding an investor conference for MLPs. What is the audience like for this conference?
DS: It is open to the public. A lot of retail MLP investors, including individuals, registered investment advisors, financial advisors, financial consultants and registered reps attend. For anyone who is actively involved in MLPs, this conference is really a must-attend event. The NAPTP is a tremendous resource for the MLP asset class. The conference gives investors an opportunity to see and listen to the managements of most of the publicly traded partnerships presenting over a two-day period, May 23rd and 24th. There are three panel discussions; I’ll actually be on one of the panels discussing recent trends in the fund industry as it relates to MLP-centric offerings.
TER: On that note, what strategies does Yorkville Capital Management use, and how exactly is it involved with MLPs?
DS: We currently offer two primary strategies. One is in the form of separately managed accounts, called our MLP Core Income Strategy. The other one is an ETF just launched in March called the Yorkville High Income MLP ETF (YMLP:NYSE). Our Core Income Strategy celebrated its 10th anniversary in December of last year. Yorkville has been investing in MLPs since the early ’90s, which is important because the asset class was only formed in the mid-’80s. Our strategy was recognized by Barron’s and Morningstar as one of the top-performing strategies last year, with 10-year annualized returns of 13.2% relative to 2.8% for the S&P 500. So on an annual basis, we were delivering over 10% above the S&P 500, which is one of the reasons why the MLP asset class is so attractive.
Our newly launched ETF was the second MLP ETF to market. It has become the fourth most successful ETF fund launched out of 90 ETFs launched in 2012, based on average daily trading volume. Yorkville seeks to capitalize on its core competency and to be recognized as thought leaders in the MLP space by educating investors on the asset class.
We recently undertook the most comprehensive study ever done on publicly traded partnerships and MLPs to create an index that analyzed every delisted partnership to better understand how risk and return distributions have evolved over time. We identified two publicly traded partnership sectors and 15 different indexes to track the MLP PTP universe. The study is unique because it’s based on the entire universe of MLPs versus a benchmark sampling. That makes it a more objective representation of the asset class and more accurately reflects the dynamic nature of MLPs showing true performance and true yield. MLPs are rapidly evolving with new sectors created within the past decade. There has even been talk about including alternative energy sources into a partnership structure. The Yorkville universe indexes would evolve with these new initiatives.
We publish our indexes on Bloomberg and Reuters and also on our website. We also publish reports on a monthly and quarterly basis to keep investors up to speed. Most investors today are solely focused on infrastructure MLPs, often called “toll roads.” Generally, they’re thinking of pipelines and energy infrastructure.
The commodity segment was very interesting to us because it was the highest-yielding segment of the asset class with the fastest distribution growth rates over time. Investors think of higher yield equaling greater risk. So we analyzed that and found that the price volatility of commodities MLPs was similar to that in the infrastructure-space MLPs. Then we looked at the volatility of distributions relative to oil, natural gas, baskets of commodities or more cyclically driven macroeconomic events, and found that the distributions are no more volatile. Therefore, we believe the commodity MLPs are a mispriced segment of the overall asset class and focused the Yorkville High Income MLP ETF exclusively in the commodity portion. This includes four sectors: exploration and production, natural resources, propane and marine transportation. The fund did its first distribution two weeks ago, yielding 8.9%, almost 50% greater than you would get from comparable infrastructure products in the market right now.
TER: Is that what you’re doing to take advantage of market volatility at this point?
DS: That is partially what we’re doing, yes. When we look at volatile markets, one of the ways to protect yourself is to take in current income, which is what MLPs do. By focusing on the commodity side of the asset class through this ETF, we’re able to maximize the income an investor receives. One of the primary benefits of MLPs is as pass-through vehicles for maximizing income, thereby mitigating some of the market price volatility. We believe investors in commodity MLPs are picking up a relatively inexpensive part of the asset class, getting higher current income and not meaningfully increasing their risk profiles. That makes a lot of sense under current market conditions. Number two, if you want to take a position in oil or natural gas or broader commodities, you have to pay to do so through futures or options. In our case, you have commodity exposure without having to be correct on the short-term price direction, and you’re paid to wait. The reason you don’t have to be right on the direction of commodities is because all MLPs are toll roads.
TER: What would you expect to happen with MLP market performance if we were to enter into a highly inflationary period, as some analysts predict, or if economic growth slows down?
DS: MLP management teams recognize that to command a premium valuation, you need to deliver consistent distributions and distribution growth. Commodity MLPs have either long-term hedging programs or long-term contracts. When oil went from $140/barrel (bbl) to $40/bbl, commodity MLPs actually increased their distributions over that period of time. Similarly, when we looked at the great recession to see if they were more exposed to macroeconomic events, again, they increased their distributions over this period.
So, you had two events to stress test the portfolio. One is the worst market that most of us have experienced in our investment careers, the great recession. The second was oil dropping to $40/bbl. In both cases, commodity-based MLP distributions maintained and actually increased. We absolutely think it’s a great place to be in the market and I think the trend, given global demand, will put a floor under pricing. Unconventional production also creates a lot more infrastructure needed to bring new sources online, whether it’s deep sea drilling off the coast of Brazil or in unconventional shale plays here in the U.S. and Canada, and bodes well for the continued growth in MLPs.
TER: What have been the best-performing industry groups and how have Yorkville’s portfolios performed relative to these groups?
DS: Our MLP Core Income Portfolio ETF was just launched a couple of months ago, so we really don’t have history on it. But our MLP/PTP beat the market on both a monthly and quarterly basis. Commodity and infrastructure MLPs are really running neck and neck so far this year. April saw a tremendous uptick, where commodities were actually up 3.5% for the month versus 2% for the infrastructure index. Commodity has had a couple of years of underperformance relative to infrastructure. Given higher yields, faster growth and a similar risk profile right now, commodities are an attractive entry point for gaining MLP exposure.
TER: Is this a good time for investors to be looking at MLPs or are MLPs good any time?
DS: As an MLP investor, I think they are good anytime. Investors are looking for yield in a low-yielding environment. So, it’s a great way to augment income in your portfolio. Investors should consider MLPs not as a tactical decision, but as a strategic asset allocation decision similar to what you make in equities and fixed income.
We view MLPs as the third asset class and suggest 20% allocation in a diversified portfolio because of high current fixed income and consistency of income, with capital appreciation over time providing an equity characteristic. If you have a 50/50 weighting, take half from your fixed income and half from your equity and put it into an MLP exposure and stay with it. You can get the benefits of portfolio diversification by putting MLPs into it and reducing the risk profile while increasing the overall return.
TER: You have talked about these MLPs in general terms. Are there any you find particularly attractive that our readers might want to consider as individual investments?
DS: One of our top holdings and favorite MLP prospects is Atlas Energy L.P. (ATLS:NYSE). Although Atlas has already seen a significant run-up of roughly 39% (excluding the Atlas Resource Partners (ARP:NYSE) spinoff) in its price year-to-date, we remain bullish on the firm’s growth prospects and our position. Atlas Energy Inc. (ATLS:NYSE) is the general partner of Atlas Resource Partners (ARP:NYSE), a developer of oil and gas reserves in which it holds approximately 64% LP interest, and Atlas Pipeline Partners (APL:NYSE), a natural gas gatherer-processor in which it holds roughly 10.5% of outstanding units. We see Atlas as a leveraged way to play the two limited partnerships, both of which we believe will grow rapidly. In our opinion, Atlas will continue to be one of the fastest-growing MLPs in terms of distributions and seems poised for further growth.
Growth should be driven by Atlas Resource Partners’ opportunistic acquisitions of natural gas reserves through purchases from Carrizo Oil & Gas Inc. (CRZO:NASDAQ) and Titan Operating LLC (private). These new reserves provide a runway for Atlas Resource Partners’ distribution growth and ultimately Atlas Energy L.P.’s equity value. Atlas Pipeline Partners recently reported strong year-over-year volume increases (ranging from +22%–+44%) at its major processing plants, WestOK, WestTX and Velma. Increased drilling activity and capital projects coming online to boost processing capacity will drive distributable cash flow growth at Atlas Pipeline Partners.
TER: Thank you for joining us today, Darren.
Darren Schuringa’s Top Ten Index Constituents
Suburban Propane Partners L.P. (SPH:NYSE)
Ferrellgas Partners L.P. (FGP:NYSE)
LINN Energy LLC (LINE:NASDAQ)
AmeriGas Partners L.P. (APU:NYSE)
BP Prudhoe Bay Royalty Trust (BPT:NYSE)
Terra Nitrogen Co. L.P. (TNH:NYSE)
Vanguard Natural Resources LLC (VNR:NYSE)
San Juan Basin Royalty Trust (SJT:NYSE)
BreitBurn Energy Partners L.P. (BBEP:NASDAQ)
Legacy Reserves L.P. (LGCY:NASDAQ)
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1) Zig Lambo of The Energy Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: None. This interview was edited for clarity.
3) Darren Schuringa: I personally and/or my family own shares of the following companies mentioned in this interview: Yorkville High Income MLP ETF , Atlas Pipeline Partners, Atlas Resource Partners and ATLS. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this story. View Yorkville disclosures here.
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