Closed-end funds that invest in master limited partnerships sport nice yields, often in the high single digits or even higher. And the discounts at which these funds trade to their net asset values have been widening, possibly signaling even better values.
Unlike open-end funds, whose shares can be redeemed by their holders, closed-end funds trade on an exchange, and their prices typically fluctuate throughout a trading session. Investors must pay a brokerage commission to buy or sell their fund shares.
MLPs are publicly traded partnerships that usually have an ownership in energy production or energy infrastructure entities–think pipelines and storage facilities.
Combining these two structures can make a lot of sense, but there are risks, among then being heavily concentrated in energy holdings and being subject to dividend cuts. But “generally speaking, MLPs have historically exhibited fairly consistent growth rates in their underlying distributions,” says Dave Lamb, who is managing director, Nuveen closed-end funds.
Just where an MLP-focused closed-end fund trades relative to its NAV “Is a good reflection of investor sentiment,” says Quinn Kiley, managing director and portfolio manager at Advisory Research, which runs three such funds: Fiduciary/Claymore Energy Infrastructure Fund (FMO), Nuveen All Cap Energy MLP Opportunities Fund (JMLP), and Nuveen Energy MLP Total Return Fund (JMF).
Right now, Kiley adds, “we are in a prolonged bear market for energy, and MLPs are caught up in that.”
West Texas Intermediate crude was recently trading at around $50 a barrel, down from the mid-70s in late-September. The Alerian MLP Index (.AMZ) is down about 12% in 2018. Even though MLPs are often portrayed as toll collectors for their facilities, they aren’t immune to commodity price fluctuations.
For more information on these funds and others, CEF Connect is a good starting point.
Another headwind for these funds has been leverage, a tool for boosting returns and offsetting tax liabilities. As short-term rates have climbed, so have borrowing costs. A common strategy for these funds is to borrow short term and buy longer-term securities to capture the spread differential.
Still, at these levels, closed-funds specializing in MLPs do look attractively valued.
There are about 20 of these funds, several of which have had to cut their distributions as cash flows from their holdings have gone down, albeit not to alarming levels. In many cases, the distributions of these funds have remained stable.
One reason for cutting their distributions, Kiley says, is that various mergers have occurred among energy companies. One such deal earlier this year involved Energy Transfer (ET), which was formed by combining two MLPs. The deal, Kiley says, simplifies the structure and allows the combined company to retain more cash flow to pay down debt and fund growth. He argues that the new structure ultimately will make the company stronger–and help boost distributions.
Holding MLPs via closed-end funds, rather than buying them directly, can simplify the process for paying taxes. “If you invest through a closed-end fund, the only income you have to account for is the dividend income you earn on your shares in the fund,” explains Robert Willens, who runs a tax consultancy for investors.
Investors in such funds, he adds, receive a Form 1099, not a more cumbersome K-1 filing that’s required for direct MLP holdings.
These funds aren’t exactly cheap, however, as many have expense ratios in the 2% range, according to CEF Connect.
And even though MLPs sport attractive yields, “You have to do your due diligence on their safety,” cautions Kiley.
But these funds are worth an initial look, especially at these discounts.
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