Late last month, Goldman Sachs Asset Management (e.g. "GSAM") announced the public listing of the Goldman Sachs MLP Income Opportunities Fund (GMZ). This is the first-ever closed-end fund issued by GSAM which was established by Goldman Sachs in 1988.
But this is not the first closed-end fund issued by the parent company Goldman Sachs (GS). They were a major closed-end fund player in 1929. Before looking at the new CEF in more detail, let's review some closed-end fund history.
In 1928-1929, there was a closed end fund mania that rivaled the internet dot-com mania of the late 1990's and the current bitcoin craze. Most closed-end funds in 1929 sold at large premiums over NAV. Pundits at the time said this was justified by the fund managers' superior ability to pick stocks.
Here is an excerpt from the "Magazine of Wall Street" , published in September 1929, with recommended guidelines for selecting closed end funds:
"Shares of an investment company capitalized with common stock only and earning 10 percent net on invested capital might be fairly priced at 40 to 50 percent in excess of liquidating value. If the past record of management indicates that it can average 20 percent or more on its funds, a price of 150 percent to 200 percent above liquidating value might be reasonable… To evaluate an investment trust common stock, preceded by bonds or preferred stock, a simple rule is to add 30 percent to 100 percent, or more, depending upon one's estimate of the management's worth, to the liquidating value of the investment company's total assets."
Here are some closed-end fund stats from the summer of 1929:
- The median closed-end fund premium in the 3rd quarter of 1929 was 47 percent.
- There was a huge issuance of closed end funds in the 3rd quarter of 1929- about 1 billion in the two months of August and September alone. This is equivalent to about 10 billion in purchasing power today, and about 60 billion relative to the size of the US economy.
- Closed end funds completely dominated new stock issuance in the summer and early fall of 1929 and crowded out other equity offerings. In June and July, ALL new equity issues were closed end funds.
- During the early 1920's, closed end fund promoters rarely disclosed their holdings. They argued that a closed-end fund had tangible assets (it's portfolio) plus intangible assets (the skills of its managers). They argued that if a fund revealed its portfolio, other investors could "free-load" and copy the fund's portfolio and avoid paying the management fee. This attitude changed abruptly after the 1929 crash, when closed end funds disclosed their holdings to make it clear that their fund was still solvent and their holdings were selling at a discount to NAV. The discounts to NAV that developed in 1930 were considered extremely abnormal and was very puzzling to the pundits of the time.
Goldman Sachs was the largest promoter of closed end funds during the 1928-1929 time period. Goldman Sachs partner Sydney Weinberg, when asked why his company had formed so many closed end funds, replied- "Well, the people want them".
In December 1928, Goldman Sachs formed the Goldman Sachs Trading Company but retained enough common stock to keep control. In the summer of 1929, it launched the Shenandoah Corporation. Goldman Sachs held most of the common stock in Shenandoah and sold common/preferred stock to the public. This established a fund of funds with leverage.
The Shenandoah Corporation then set up the Blue Ridge Corporation, holding most of the common stock itself and selling common/preferred stock to the public. This established a multi-level fund of funds with leverage at two levels. Any gain in Blue Ridge would be passed on to Shenandoah with leverage, and these gains would be further magnified as they flowed back to Goldman Sachs Trading.
The Blue Ridge Corp sold at a 46% premium in August 1929, but fell to a discount of 24.5% by 1930. The Shenandoah Corp sold at a 103% premium when it first came out as a new issue in 1929. Goldman Sachs discovered that leverage is a two way street and the Goldman Sachs Trading Corporation stock collapsed from its high point of $326 a share in 1929 to $1.75 in 1932.
The reputation of Goldman Sachs was badly hurt by these closed-end fund offerings and may explain why management has avoided issuing any new closed-end funds for more than 80 years. But banking regulations have restricted the scope and profitability of their traditional pure trading business. The new CEF is a natural expansion of their fee generating business.
Now let's take a look at the new MLP closed-end fund. Master Limited Partnerships ( or MLPs) have been one of the best performing asset classes over the last decade on a risk-adjusted basis.
Tax considerations are important when evaluating energy related MLPs. In taxable accounts, I would generally recommend that high net worth investors own individual MLP's to get the full tax benefits. But in tax deferred retirement accounts, MLP closed-end funds are very convenient. If you directly purchase an MLP, you will receive a K-1, and may be subject to unrelated business taxable income (UBTI). You may also need to file tax returns in several states.
Here are some of the key characteristics of closed-end funds that own MLPs:
- You will receive one Form 1099 per shareholder instead of multiple K-1 forms.
- Most MLP CEFs are organized using a C-corp structure, not the usual registered investment company (RIC). CEFs are not structured as RICs because no more than 25% of an RIC can be invested in MLP securities (American Job Creation Act of 2004).
- MLP CEF dividends are considered qualified dividend income (QDI) and a portion of the dividends are normally classified as return-of-capital.
- MLP CEF shares do not generate unrelated business taxable income (UBTI) or state taxes in IRAs.
- These funds generally use leverage- the new Goldman MLP CEF plans to use about 20% leverage.
Goldman Sachs MLP Income Opportunity Fund is a closed-end fund designed to provide an efficient vehicle to invest in a portfolio of publicly-traded master limited partnerships. It seeks to provide a high level of total return with emphasis on current distributions to the shareholder.
The fund plans to invest at least 80% in MLPs and will focus on midstream infrastructure. These companies include pipeline operators, processors and fractionation and storage facilities. They may also invest up to 20% in upstream or downstream energy companies. The fund will invest in many of the large MLPs, but they also plan to look outside of the Alerian MLP index with a bias toward smaller companies.
"We have strong conviction that compelling opportunities in MLP investing lie with midstream companies collecting toll-like revenues, which, we believe, are less exposed to underlying commodity prices," said Kyri Loupis, Managing Director and lead portfolio manager for the Fund. "Our index-agnostic approach and closed-end structure allows us to execute on our best investment ideas, including those offered by smaller cap MLPs poised for higher levels of growth."
The fund may invest in PIPEs or other restricted securities, and may also invest in ETFs and ETNs. There are strong anti-takeover provisions. A conversion to an open-end mutual fund would require a 75% shareholder vote.
It is still too early to do a detailed fundamental analysis of this fund, since the fund was only launched on November 27. The fund management has estimated that it will take about three months to fully invest the proceeds.
I was surprised that Goldman Sachs took a relatively small allocation of the initial public offering. Here are some of the top underwriters:
Top 5 Underwriters
Morgan Stanley & Co
Citigroup Global Markets
Oppenheimer & Co
Stifel Nicholas & Co
In contrast, Goldman Sachs & Co. was only allocated 32,000 shares. I guess they targeted this offering for smaller retail investors and not to Goldman's high net worth clients.
Here are some things I like about GMZ:
- The closed-end fund format will allow GSAM to use leverage, derivatives and hedging expertise to manage the portfolio.
- The management fee of 1% unleveraged, and 1.25% leveraged is more reasonable than many of its competitors. The wealth management arm of Goldman has been a strong investor in midstream MLPs for over 10 years. They were large owners of most of the top-tier MLP companies.
- GMZ has a large concentration in midstream MLPs. This sector should benefit from increased infrastructure needs related to emerging domestic production of crude oil and liquid natural gas. Many of their holdings are involved in lower risk fee-oriented services such as pipeline transportation and storage.
- GSAM has a strong incentive to make this new CEF a success. They would like to sell more products to the retail space in the future. They may be able to gain access to attractive private investments.
Here are some things I don't like about GMZ:
- Valuation: It is generally a mistake to buy closed-end funds at the IPO price because of the premium caused by the sales load.
- GMZ is still invested mainly in cash. It will take about three months to become fully invested. Until then, it is basically a very expensive money market fund.
- Recent MLP IPOs have had big drops in their market price and are trading at discounts to NAV. These funds will compete with GMZ which is still selling at a 5% premium:
-CEN Issued: 9/26/2013 -10% discount
-FEI Issued: 11/28/2012 -9% discount
-NML Issued: 3/26/2013 -9% discount
Current opinion: I believe it is too early to purchase GMZ, but it is a good fund to put on a watch list. It may be a worthwhile purchase in about six months if/when the fund starts selling at a 5% or more discount to NAV.
Here is some summary information on GMZ:
Goldman Sachs MLP Income Opportunity Fund
- Offering Price: $20.00
- Initial NAV= $19.06
- Total Assets: 826 Million (will increase when leverage is deployed)
- Inception Date: Nov 26, 2013
- Estimated Baseline Expense ratio: 1.48% (Management fees 1.25%)
- Premium over NAV= +4.9%
- Estimated Leverage: 20%
- Leverage Type: Multiple forms allowed
- Average Daily Volume (shares)= about 100,000
- Average Trading Dollar Volume = about $20 million