Quinn Kiley: MLPs Going Institutional
Source: Brian Sylvester of
The Energy Report
09/02/2010
http://www.theenergyreport.com/pub/na/7267
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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 and suggests
some names with catalysts for growth.
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%. And the
Alerian MLP Index (NYSE:AMZ)
fell by 5% over 4 days' trading in early August. 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. Last week, the
Fiduciary & Claymore MLP Opportunity Fund (
FMO
)
, a closed-end fund, conducted a public offering of 4.25 million
shares. These 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:
We sub-advise for two MLP-focused closed-end funds, FMO and the
MLP Strategic Equity Fund Inc. (
MTP
)
. Both of those funds are broader MLP-focused closed-end fund
products. Calling these funds "roach motels" is a misnomer and,
frankly, an injustice to those investors who have taken advantage
of the MLP asset class through these vehicles. This isn't someone
who, typically, is allocating $5M to the MLP space. It's someone
who's buying as little as 1 share and as many as 100,000. They want
to do it without incurring additional accounting and tax paperwork.
They're trading complexity for the simplicity of buying MLPs
through a closed-end fund. There's a fee associated with that
structure, but it meets investors' needs.
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 whether it is
AT&T Inc. (
T
)
,
Kinder Morgan Energy Partners, L.P. (
KMP
)
or
Exterran Holdings Inc. (
EXH
)
, a smaller MLP. 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. For
example, if you were a typical retail investor, you wouldn't be
able to participate in a private placement buying
Plains All American Pipeline, L.P. (
PAA
)
at a 3% discount to the market price.
TER:
Over the last 10 years, what's been the average YOY return on your
MLP investment strategy?
QK:
Since its inception, the Alerian Index has returned approximately
16% annually. Over that same timeframe, 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.
TER:
What are some of your favorite MLP names poised for growth?
QK:
As I mentioned, there's a broader suite of MLPs available for
investment. I thought it would be interesting to talk about three
very different MLPs.
Regency Energy Partners, L.P. (
RGNC
)
is probably more widely held and followed than the others. Regency
has gone through several transformations; it was originally
launched with a general partner (GP) that was owned by a private
equity firm. Most of the transformations have centered on where the
GP was going to take Regency. Historically, it was a gathering and
processing MLP with higher-than-average commodity price exposure,
located in northern Louisiana and in the mid-continent region.
Control of that entity later transferred to
General Electric Company (
GE
)
, which had a significant suite of investments in the
infrastructure world. General Electric's ability to finance
large-scale projects and its ownership of significant pipelines led
people to believe Regency would become a pipeline MLP.
Consensus on the Street was that that's where it was going and
it should be valued that way. We thought valuation had gotten ahead
of itself. The correction we saw in 2008 kind of righted that ship
and was overly punitive to the name. Meanwhile, they were building
out their pipelines and marching toward an impressive suite of
Haynesville Shale assets-one of the more exciting shale plays. Then
GE sold its interest in the GP to
Energy Transfer Partners, L.P. (
ETP
)
, a well-respected, high growth-oriented MLP that is diversified on
the gas and propane side. But ETP used a gas pipeline it owned as
currency to fund the transaction. Now, Regency is a diversified
natural gas MLP that has pipeline and gathering and processing
exposure and some compression. Regency has a footprint that sits
right over top of the Haynesville Shale. Its story illustrates how
MLPs have evolved from smaller private equity or
corporate-sponsored entities into larger-scale, growth-oriented
entities.
TER:
And the next one?
QK:
Looking at the coal subsector, a name we have always been a big
supporter of is
Alliance Resource Partners, L.P. (
ARLP
)
. There are four coal MLPs right now-two run the operations and two
are royalty plays. They own the coal themselves, but they don't do
the mining. Alliance does the mining. They either own the reserves
or lease them. They control the operations and they, effectively,
control their destiny. Because it happens to be in the hands of a
very strong management team, Alliance has delivered very well on
the value proposition it offers. It's been able to buy and operate
successful mining operations, create new mines on previously
undisturbed reserves and grow its distribution over the long term.
The company's done it with a very conservative coverage ratio,
which is just the difference of cash available for distribution
over the amount of cash actually distributed from the partnership.
The higher that coverage ratio, the more conservative the approach.
With direct commodity price exposure, a coal miner or an oil and
gas producer should probably have a higher coverage ratio relative
to a pipeline that may have very little commodity price exposure.
We think Alliance does a very good job of managing that.
More importantly, unlike every other MLP, Alliance reserves
enough cash to actually fund its growth. Historically, the vast
majority of its growth has been funded by the cash it reserved, as
well as on the credit side of their balance sheet. Alliance is not
a serial issuer of equity. As you know, sometimes issuing too much
equity can be bad for the performance of the underlying MLP; so
Alliance has done a couple of things that make a lot of sense to
us. It's profitably managed its business, delivered growth-and done
it with a very strong balance sheet and conservative approach to
its distributions, which we like. It also gives them dry powder for
future opportunities and future distribution increases. With
several of its mines having come online last year and through to
2011, we expect them to be in a position to continue to deliver
growth. The one caveat to all this is that coal is in the
crosshairs of the policymakers and environmentalists. We've seen
some negative impact through that in the Appalachian area where
Alliance has some operations; but they tend to be more focused on
the Illinois basin, which has been a little more coal friendly.
TER:
You said three, what was the other one?
QK:
The third one is
Inergy, L.P. (
NRGY
)
-an MLP that, historically, was a retail propane provider. They've
evolved into a diversified company that has propane as a core
business, as well as some pipelines and natural gas storage.
Interestingly, they've done it in an area of the country that has a
lot of demand for natural gas-the Pennsylvania/New York region.
But, maybe more importantly, they are in the Marcellus Shale, which
is another large shale play that's very exciting for energy
investors. Inergy happens to be sitting right in the middle of it
and has access to the New York and New England markets.
We think that they've done a good job of evolving their model
over time. One of the reasons I think it's interesting to talk
about them is they're a well-run company that's delivered a lot of
growth. But they're going through a restructuring whereby NRGY is
acquiring the GP,
Inergy Holdings, L.P. (
NRGP
)
, and they are doing it because they believe it's a cost-to-capital
advantage over the long term. It's a wait-and-see on Inergy. They
have attractive core businesses with good assets and a good
footprint, but their structuring issues have created some
uncertainty.
TER:
It's noteworthy that the bigger company acquired its GP. That seems
to be something of a trend in the space.
QK:
Well, it has been happening over the last two years at an
increasing rate. Often, the rationale is-because of the amount of
cash flow that must flow to the GP, it's incrementally more
difficult to raise the distribution to the limited partner (LP),
which is where the majority of the assets sit. LPs tend to say:
"Let's eliminate it!" But they usually do it by buying GPs at a
very high multiple. The result is that the near-term
recapitalization has near-term negative implications. But the
transaction is done with the longer-term view that, as growth
resumes, they'll be able to pass more of the cash flow growth to
the LP investor. We've seen this happen several times. I think we
honestly have to take a step back and say: I understand why this
makes sense, but over the long run have we really seen an
incremental increase in distributions to the LPs? Time will tell.
But with the uncertainty in tax policy going on in Congress,
there's a lot of incentive for people to do this now-as opposed to
waiting for a new tax regime in which they don't know how they'll
be treated. I think there's a tax part of this that's really
driving a lot of these transactions.
TER:
What are some MLP names that may not have the brand equity of some
of the bigger names but have significant growth catalysts?
QK:
As far as existing MLPs that have done a good job of delivering
growth and have some opportunities, I think you have to look into
the gathering and processing space. That group has had phenomenal
performance over the last year and a half but was just absolutely
crushed in the selloff of 2008. These names have yet to fully
recover-names like
MarkWest Energy Partners, L.P. (NYSE.A:MWE)
, which is about a $2.5 billion market cap. They have opportunities
inside the Marcellus Shale. You look at
Targa Resources Partners, L.P. (
NGLS
)
, with a little less than a $2 billion market cap, it is really
well positioned in the natural gas liquids market and the logistics
business. We think they have near-term opportunities, as well.
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.
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DISCLOSURE:
1) Brian Sylvester 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
or
The Gold Report:
Energy Transfer Partners.
3) Quinn Kiley: I personally and/or my family own shares of the
following companies mentioned in this interview: Fiduciary/Claymore
MLP Opportunity Fund, General Electric, Plains All American and
Exterran. I personally and/or my family am paid by the following
companies mentioned in this interview: Fiduciary Asset
Management.
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