MLPC Offers Solid Stock Selection in Potential Reversal Markets
So far this year, the commodities sector has been one of the most volatile trends in any of the major financial markets. Oil prices have shown some of the best examples of this, and the commodity has posted its longest string of quarterly declines since 2003. Most of the drop has come as a result of changing expectations for the supply and demand dynamics in these markets. Recent developments in Iranian crude exports seem to support this outlook, at least in the near term. But in the chart below we can see that the bearish trade is starting to show signs of stabilizing at the lower levels:
(Chart Source: iForex)
For those looking ahead with a longer term view, it makes sense to start looking for ways to play the rebound once supply levels normalize in ways that match the historical trends. One way of doing this is to take a closer look the master limited partnership (MLP), which is essentially a company that organizes itself as a partnership. Most MLPs are focused on the energy sector, and are divided into two broad categories: upstream and midstream. MLPs that fall into the upstream category deal with businesses that might drill for oil and gas while midstream MLPs are more service-oriented (in areas like pipeline development, logistics, and storage). Upstream MLPs tend to be more volatile, and might be viewed as less appropriate for those looking to invest in a more conservative fashion.
Major Industry Benchmarks
When looking at specific investment options, there are a few major players that stand out in the MLP arena. To gauge success or weakness in the sector, most investors use benchmarks like the Alerian MLP Index, which tracks activity in 50 large- and mid-cap MLPs and has over $17 billion in assets linked to its indices. But there are newer players that have entered into the space that offer a more streamlined approach to assessing activity in the MLP market.
One of the more interesting selections here is the C-Tracks Exchange Traded Note (MLPC), which tracks the Miller/Howard MLP Fundamental Index (MLPMH). The index is composed of 25 MLPs that are selected based on distribution growth, distribution coverage, and estimated capital expenditures. Within the index, there are 15 large-cap stocks (each with a 5% allocation) and mid-cap stocks (each with a 2.5% allocation). Each of these selections is associated with high liquidity levels and the balance between large- and mid-cap stocks creates the potential for reduced volatility and long term growth in a single instrument. This streamlined approach helps reduce some of the investment risks when compared to the Alerian MLP index, which is less critical in choosing the stocks that are included.
Stock Selection in MLPC
MLPC is an exchange traded note (ETN) that is underwritten by Citigroup (C) and began trading in September of 2013. Since it is a newer entrant into the MLP space, it is not as well known by investors -- and this creates some interesting opportunities for those looking to capitalize on its incentive selection strategies. No more than 15% of the Miller/Howard MLP Fundamental Index is devoted to upstream assets, so conservative investors are less likely to encounter the higher volatility levels typically seen in that space.
Specific stock selections in the index are based largely on the potential for distribution growth, which if often considered to be standout advantage for MLP investments. This growth potential means that income streams can rise over time -- something that cannot be said for fixed distributions. Since its inception, distribution growth in the Miller/Howard Fundamental Index has surpassed the Alerian MLP Index by more than 3% at some stages, so it is clear that the selective strategy to focus on fewer stock choices has paid off.
Chart Source: MH Investments
This strength is given added confirmation when we look at the historical performance of the stocks that make up the index. Miller/Howard Investments conducted a back test of the stocks in its index, going back to 2008. The results were surprising, given the fact that the index had no trouble beating both the Alerian MLP Index and the S&P 500 on a short, medium, and long term basis. Over five years, MLPMH outperformed the S&P 500 by a 12% margin, even as the S&P 500 posted some of its strongest gains in history and rose to new all-time highs.
Benefits of MLPs
All of this makes a compellingly bullish case for the MLP space as a whole, and for MLPC in particular. “There are several advantages that MLPs offer when compared to some of the more traditional asset classes,” said Michael Carney, commodities analyst at Teach Me Trading. “Factors like high yield, consistent distributions, lower costs of capital, and strong potential for capital gains are all things that should be considered by new investors.”
It should be remembered that investments in MLPC also come with a dividend yield of 5.4%, which is very strong given the low-interest rate environment currently seen in US markets. So, it is clear that MLPC delivers on all of these fronts -- and has already shown an ability to outperform the market with its streamlined selection strategies. Watch for continued strength in MLPC going forward.
