HardAssetsInvestor

Written by Lara Crigger  |

February 11, 2010

Daniel Spears: The Index Approach To MLPs

Details

This overlooked asset class is commodities' best-kept secret, says a partner and portfolio manager for Swank Capital.

• How MLPs are like REITs
• How to use MLPs to hedge inflation
• The details on the new Cushing 30 MLP Index

 

Energy and natural resource master limited partnerships (MLPs) have yet to catch on among many investors, despite their numerous advantages, such as high yields, stable income and immunity to volatility in commodities prices. But Swank Capital, LLC is working to change all that; this Texas-based boutique investment manager has recently launched the Cushing 30 MLP Index, a new benchmark tracking North American infrastructure MLPs.

Daniel Spears, a partner at Swank Capital, is no stranger to MLPs. With 14 years' experience in investment management and investment banking within the natural resources sector, Spears is an expert in energy and infrastructure MLPs. He also currently serves as portfolio manager for the Swank MLP Convergence Fund, L.P.

Recently, HAI Associate Editor Lara Crigger chatted with Spears about MLPs, including how MLPs are like REITs, how investors can use MLPs to hedge inflation and what's behind the company's new Cushing 30 MLP Index.

 

Lara Crigger, associate editor, HardAssetsInvestor.com (Crigger): What advantages do MLPs offer investors over other types of commodity-based investments?

Daniel Spears, partner, Swank Capital (Spears): First of all, the majority of MLPs are not commodity-sensitive organizations. Most MLPs are created primarily to hold assets that have tremendous amounts of cash flow, such as pipelines, etc. It is a model similar to REITs: Just as REITs have to distribute all of their income to shareholders, and they're not taxed at that level, MLPs have to distribute all of their cash flow to investors and are not taxed at a corporate level.

Predominantly the midstream MLPs hold pipelines, processing plants, crude storage tanks or crude pipelines, or they hold refined products like gasoline or jet fuel, and those pipelines and those storage facilities. That means MLPs really are the middle of the road: On one end, you have the companies out there, poking holes in the ground, looking for oil and natural gas; and then on the other end, you have the consumers. MLPs are the "toll roads" in between.

Crigger: MLPs' agnosticism to commodities prices helped them weather the down market last year. What's the outlook for 2010?

Spears: Our view is that for 2010, we should see growth in distributions return. Last year, it was about 4 percent. The previous few years, it had been 9-12 percent. So I think in 2010, you're going to see distribution growth come back into the 4-6 percent range.

That said, a lot of companies are spending dollars today that will add substantially higher growth in 2011. And the companies that have amassed this distribution growth should outperform.

Crigger: MLPs are often touted as a way to hedge inflation, but are some MLPs better at this than others?

Spears: The way I look at using MLPs as an inflation hedge is to compare their underlying distribution growth with the CPI; that is, if you have a view on where CPI is going, then you should look into investing in an MLP whose distribution growth is higher than that.

You can also look at which companies have embedded CPI protection in them. A lot of those companies are on what we call the "products pipelines." Magellan [Midstream Partners, LP (NYSE: MMP)] is one example. They own a lot of pipelines that simply transport diesel and jet fuel - the end-crude product. Their pipelines are FERC [Federal Energy Regulatory Commission] regulated, and then there's a FERC-regulated adjustment based upon the finished goods PPI mix. Therefore, their tariff goes up by the PPI; it's just part of the formula. So there's the embedded feature of inflation production.