ENERGY BOOM, INCOME DEMAND BOOST INTEREST IN MLPS
Managers with separately managed accounts (SMAs) and funds of master limited partnerships (MLPs) have been raking in high-net-worth assets, a trend that appears far from over.
The U.S. oil and gas industry boom, coupled with the demand for income in a low interest rate environment, have boosted interest in MLPs, says Matthew Sallee, managing director and portfolio manager for Tortoise Capital Advisors. Those factors have been a boon for Tortoise Capital Advisors’ MLP strategies, Sallee says. They have also helped boost adoption of the firm’s ancillary offerings, such as a downstream-focused bond fund with utilities and pipeline debt, and exploration and production-focused closed-end fund, he says.
The oil and gas resurgence in the U.S. has been, and should continue to be, a significant growth driver, as well as creating new investment opportunities for managers, he says. “That’s been a huge tailwind for anyone investing in the space,” Sallee says. “People like what’s going on in energy. At the same time, people have been looking for income.”
Montage Investments affiliate Tortoise now has more than $8 billion in separate account assets, including both institutional and high-net-worth portfolios. Overall the firm has about $18 billion in assets under management. MLP-based strategies make up the bulk of that, says Sallee.
Across the industry MLP-based strategies have been attracting flows in both SMA and fund format. A list of 28 MLP-based separate accounts and collective investment trusts (CITs) tracked by Morningstar saw $4.8 billion in estimated net flows in 2013, more than double the $2.1 billion those strategies gained in 2012. While the data on SMA flows often lags that of mutual funds, 25 MLP-based SMAs tracked by Morningstar attracted $336.7 million in net flows in the first quarter of 2014.
The six MLP-based SMAs tracked by Informa represented $10 billion in overall assets at the end of June, up from $7.7 billion at the end of 2013.
MLPs were enabled by a law allowing creation of companies chartered to own and run energy sector infrastructure to sell unit shares and pay untaxed income to investors, without paying corporate income taxes. To qualify, companies must earn more than 90% of their income from activities including exploration, development, mining, processing, refining and transmission.
While MLPs can be used for certain types of investments outside of the energy sector, they remain a popular instrument for investors to gain exposure to the sector. Nearly 90% of the MLP market capital is in energy-related business, with the majority in midstream related products, according to a fact sheet from the National Association of Publicly Traded Partnerships.
SMAs are the main vehicle through which wealthy investors in the TIGER 21 network access MLPs, says Michael Sonnenfeldt, founder and chairman of Tiger 21. He sees most member interest directed to oil and gas distribution, or pipeline-related opportunities. “One of the greatest stories of our decade is this energy explosion,” Sonnenfeldt says.
While the typical allocation is around 5%, some wealthy investors in the network have allocated as much as 20% to MLPs, Sonnenfeldt says.
Most of the high-net-worth investors in the TIGER 21 network don’t mind the added tax complexity of owning the underlying MLPs within an SMA structure, Sonnenfeldt says. He also sees investors accessing MLPs through long-only hedge funds, direct ownership, and occasionally through long-short MLP hedge funds.
While future changes in tax laws could affect MLPs, most TIGER 21 members consider changes in MLP tax status unlikely. And although the recent announcement that one of the biggest MLP firms, Kinder Morgan, is unwinding its MLP structures in a buy-out of its existing subsidiaries has spurred speculation over broader implications for industry, Sonnenfeldt expects the move is likely an anomaly and doesn’t expect others to shun the MLP structure.
For its part, Kanaly Trust currently recommends about a 5% allocation to MLPs to wealthy clients, says James Shelton, the firm’s CIO.
“With the attractive dividend yields, clients like them very much,” Shelton says. “The only thing clients don’t like about them is that the tax reporting is complex, to say the least.”
But Kanaly Trust typically turns to mutual funds, or to an LP structured vehicle to deliver MLPs, as well as using individual MLPs for some larger clients. The firm elects not to use SMAs of MLPs, because of the tax complexity for clients, who then own the underlying MLPs, and receive separate tax documents for each underlying investment.
“The drawback to SMAs is if you invest in 15 MLPs in the SMA, you will receive 15 K-1s,” Shelton says. “If you’re going to use an SMA you have to make absolutely certain you have a savvy high-net-worth individual who is okay with receiving all of those K-1s.”
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