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-- Posted Thursday, 2 September 2010 | | Source: GoldSeek.com
Fiduciary Asset Management Senior Portfolio Manager Quinn Kiley is a big believer in the MLP space and sees opportunities in closed-end funds and among individual MLPs. In this exclusive and candid interview with The Energy Report, Quinn discusses the state of the MLP asset class.
The Energy Report: Today we're talking with Quinn Kiley, senior portfolio manager of Fiduciary Asset Management's Master Limited Partnerships (MLPs) products. Tell us about FAMCO and what you do there.
Quinn Kiley: Our business is built around providing custom solutions to individuals and institutional investors. Unlike a lot of the other MLP investors, MLPs are only one of the things we do. We also have a significant fixed-income business and a significant large-cap core equity business. The vast majority of our business is on the institutional side.
As you know, MLPs have, historically, been the purview of taxable retail investors. Our history in that space developed along those lines, too. We manage separate accounts for high net-worth individuals. We also offer that strategy through several broker/dealers, whereby their clients have access to our strategies and we manage the accounts for them. We do the same thing for some institutions and closed-end funds—we run the portfolios for those funds.
TER: With T-bills fetching record low yields and MLPs averaging almost 7%, is it easier to sell investors on MLPs now or do you still need to educate them about being in MLPs?
QK: It's now easier to have a conversation about MLPs because they are much more in the front of people's minds. However, the understanding about what an MLP is, how it fits in a portfolio and why it makes sense for a range of investors is still a topic that we have to cover in most of our meetings. MLPs are a growing asset class that is becoming more prominent, as entities like The Energy Report are discussing the topic in depth. The conversations are still ranging from introductory to deeply analytical, depending on the sophistication and knowledge of the investor you're talking with.
TER: Are you seeing a change in the type of investor being drawn to MLPs?
QK: For 15 years, the firm has been managing MLP portfolios for taxable high net-worth investors and, more recently, for institutions. Over the last five or six years, we've really seen an evolution in the MLP space with the advent of the closed-end funds that were launched in 2004 and 2005. Those funds initially brought institutions into the asset class. Interest in MLPs has continued to grow, and we've seen significant funds raised this year in closed-end funds. We've seen several other MLP vehicles, as well. Periodically, we've seen hedge fund interest. We've seen name-brand mutual fund interest, and that is growing, but it's been a small piece of the overall pie.
Retail investors still make up about 70% of the space; but, with the attractive yields of MLPs relative to everything else, we're seeing a lot more institutional interest. We're moving in that direction. It's part of the evolution of every asset class.
TER: What are some other noteworthy trends over those 15 years?
QK: The MLP asset class today is not what it was 10–15 years ago. Back in the late 1990s, there was only a handful of MLPs to choose from. They were all generally very conservative energy infrastructure MLPs handling oil-refined products, natural gas, natural gas liquids (NGLs) and propane. And there was a broader group of MLPs that was phasing out of the MLP structure as they reacted to regulatory changes.
In the last decade, we've seen MLPs really deliver total returns based on fundamental growth by acquisitions or by constructing new assets. But we've also seen an expansion of the risk spectrum inside the MLP space as new subsectors have been added. For example the oil- and gas-producing MLPs, which have significant commodity price risk. The asset class has grown not just in number, but also in terms of potential risk and opportunities. Today more than ever, an investor needs some sort of professional advice when investing in the space.
TER: We've talked about where MLPs have been and where they are now. Where is asset class headed?
QK: I think we're at the beginning of the institutionalization of the MLP asset class. MLPs are a smaller asset class, about a $190 billion market capitalization. The liquidity is improving; the reporting has been improving for years. Governance has been improving, too. But more importantly, we're getting to the point where there is enough scale for an institutional investor to invest. That was not true even five years ago.
If you look at the way Real Estate Investment Trusts (REITs) evolved, they provided a tax advantage structure that made it logical to capitalize real estate in that form. I think that's true of MLPs today. But, today, you're seeing new assets being formed in the MLP structure. You're seeing MLPs being the buyer of choice in certain parts of the energy world. You're seeing MLPs being the builder of choice for most of the pipelines in the U.S. Combine this stable cash flow growth with high yield and lower correlation and you have an asset class institutional investors should find attractive.
As MLPs grow and take advantage of those opportunities, the liquidity will increase. And the opportunities for investors will increase. I think we're at the early stages of the maturing of this asset class.
TER: You mean they're acting like more typical equities.
QK: Clearly. They have some fundamental characteristics that make them look a lot different from the broader market; but, in times of stress (like we saw in the fourth quarter of 2008), MLPs correlated very highly with the broader equity markets. Over the long term, because of the tax structure and the stable underlying cash flow of the majority of MLPs, they tend to break away from the herd and demonstrate lower correlation over longer periods of time. I don't think that's going to change. But they are a traded equity, and they're susceptible to the things all traded equities are susceptible to.
TER: MLPs have typically been regarded as low-beta investments or investments that are not subject to massive price swings. However, in July and August, we saw price swings of greater than 1% on 9 days, and 2 days exceeding 2%. What's happening?
QK: If you look at MLPs at the end of last quarter, I think the projected beta vs. the S&P and the measured data were both about 0.75, so they are generally lower beta than the S&P 500 for some of the reasons I already mentioned. I think it would be misleading to suggest that something evolutionary is happening. The reality is that you don't have nearly 20% annualized returns over a 15-year period if you don't have significant price moves. Though substantially driven by yields and growth in those yields, those gains are also largely driven by price moves. Although the MLP market of yesteryear was, perhaps, more stable and more yield-driven, we have had significant volatility in the last decade over shorter periods.
If you look back over the last 15 years of MLPs, there have been five cycles of bull and bear markets. In many cases, the bear market starts with too much new equity being sold into the market. In the fourth quarter of 2005 you saw an excess of IPOs. In 2007 and 2008, you had levered hedge funds indiscriminately selling. At the beginning of August this year, over a very tight time span, the asset class saw an IPO and a significant number of secondary offerings come to the market. The market didn't have time to digest them, and you saw supply overwhelm natural demand for a short period of time. But, generally speaking, I think the volatility mirroring that of equities is not new to the MLP asset class and is probably what we should expect going forward.
TER: I think it's interesting that, as MLPs are run more like typical companies, their performance in the market is starting to mirror that. Closed-end funds are quietly known as "roach motels" because you can check your capital in but you can't easily check it out. Tell us about the upside of being in these funds.
QK: MLPs span a wide spectrum of capitalization from $20 billion market caps down to $100 million. They can trade from many millions of dollars in units a day to very few thousand dollars. A closed-end fund is, generally, more liquid than many MLPs and less liquid than others. The reality is an investor's ability to get cash out of a closed-end fund is no different than buying any share of any stock. Liquidity should be a consideration for all investors, whatever they're buying.
TER: So what are some closed-end fund advantages?
QK: If you think about the closed-end fund universe, there are maybe nine dedicated closed-end MLP funds that are nearly 100% invested in a portfolio of MLPs. I would say there are four advantages of being in closed-end funds:
- Access to liquidity in the broader market on a scale that institutional size creates. Whether that's buying blocks of units as they trade on the open market or getting allocations following IPO offerings, it's access that an individual investor would not have.
- Closed-end funds are all professionally managed by some of the leading investors in the MLP space. That allocates some of your risk in terms of stock selection toward professional management.
- You own a single security that is a closed-end fund share but you're getting exposure to 20–50 MLPs. To do that as an individual would get you 20–50 K1s and multiple state tax filing issues (closed-end fund unit holders receive one 1099 for each fund in which they hold units). That's a headache that a lot of investors don't want, especially in tax-exempt settings.
- Many of these closed-end funds have historically bought restricted shares or units of MLPs that are issued at a discount-to-market price. And because the pools of capital are dedicated to the MLP space, they can take a less liquid security and be good holders of it over a longer period of time.
TER: Over the last 10 years, what's been the average YOY return on your MLP investment strategy?
QK: Since its inception, our MLP composite has annualized returns of 18% gross of fees. I think it's important to put what happened over that time period and what's going to happen over the next 10–15 years in perspective. We, as a firm, don't believe MLPs will earn 20% a year into infinity. Our view is that we've had a significant spree of necessary infrastructure investment in this country, and MLPs have benefited very much from that. But over those 10–15 years, we've effectively been in a long-term falling interest rate environment. As a yielding security, MLPs benefited from that. Going forward, we expect interest rates are going to turn around and start rising; it's probably going to be next year or later depending on what the economy does. That is going to have an impact on all yielding securities. Our view is that MLP returns will have a yield of around 7%, plus long-term distribution growth of 4%–6%. That means a low double-digit return, which we think is attractive in any market but not as attractive as MLP returns over the last 10 years.
Quinn T. Kiley is the senior portfolio manager of FAMCO's Master Limited Partnerships product and is responsible for portfolio management of the firm's various energy infrastructure assets. Mr. Kiley serves a portfolio manager for the Fiduciary/Claymore MLP Opportunity Fund and the MLP and Strategic Equity Fund, Inc. Prior to joining FAMCO in 2005, Mr. Kiley served as VP of Corporate and Investment Banking at Bank of America Securities in New York. He was responsible for executing strategic advisory and financing transactions for clients in the energy and power sectors. Mr. Kiley holds a BS with Honors in Geology from Washington and Lee University, an MS in Geology from the University of Montana, a Juris Doctorate from Indiana University School of Law and an MBA from the Kelley School of Business at Indiana University. Mr. Kiley has been admitted to the New York State Bar. Streetwise - The Energy Report is Copyright © 2010 by Streetwise Reports LLC. All rights are reserved. Streetwise Reports LLC hereby grants an unrestricted license to use or disseminate this copyrighted material (i) only in whole (and always including this disclaimer), but (ii) never in part. The Energy Report does not render general or specific investment advice and does not endorse or recommend the business, products, services or securities of any industry or company mentioned in this report. From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise. Streetwise Reports LLC does not guarantee the accuracy or thoroughness of the information reported. Streetwise Reports LLC receives a fee from companies that are listed on the home page in the In This Issue section. Their sponsor pages may be considered advertising for the purposes of 18 U.S.C. 1734. Participating companies provide the logos used in The Energy Report. These logos are trademarks and are the property of the individual companies.
-- Posted Thursday, 2 September 2010 | Digg This Article | Source: GoldSeek.com
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