AMZA And MLP Funds: Clipping The Coupons While Waiting For Recovery

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Includes: AMZA, CEN, DSE, EMO, FMO
by: Steven Bavaria
Summary

"Keeping the faith" with AMZA and our other MLP funds has paid off, so far.

Accumulated cash income (i.e. distributions received) over the past year is about four times our current "paper loss" on the sector.

The lesson: High yields can help you dig out of poor purchase and/or timing decisions relatively quickly, compared to lower yielding assets.

It's easier to wait and assess a tricky situation if you're being paid well while doing so.

There have been a lot of articles and comments in recent months about the InfraCap MLP ETF (AMZA) and other MLP and MLP funds, particularly with respect to whether AMZA could or could not cover its distribution going forward, and more generally whether the beleaguered MLP sector would bounce back as the market recognized its cash-generating ability was still largely unimpaired despite a host of recent corporate, financial, tax and regulatory issues that have apparently disturbed and/or confused its investor base over the past year or so.

I even contributed to the hand-wringing with my own article in March suggesting that while I might not have chosen to jump into AMZA or the MLP sector de novo at that point, having already made the commitment I was inclined to clip my coupons and hope for the best, rather than risk selling out at the bottom.

That appears, so far, to have been the right choice.

Throughout 2017, I had built up a position in AMZA and a few MLP closed end funds, including Duff & Phelps Select Energy MLP Fund (DSE), ClearBridge Energy MLP Opportunity Fund (EMO), Fiduciary Claymore MLP Opportunity Fund (FMO), and more recently Center Coast Brookfield MLP & Infrastructure Fund (CEN). (Shout out and thanks to Jim_Likes_Dividends for alerting us all to CEN!)

My original premise was (1) that MLPs have provided essential infrastructure the need for which was not going to disappear for quite a while, and (2) that like most corporate managements everywhere, MLP business leaders probably would eventually figure out how to deal with whatever tax, corporate structure, financing and regulatory issues they were faced with. It also seemed like, by most accounts, MLPs were continuing to churn out cash flow despite their depressed stock prices, so buying in and collecting the (hopefully steady) income while waiting for the eventual rise in prices was a reasonable strategy.

My faith in this plan, as well as my patience, were tested later in 2017 and early 2018 when the MLP sector, after a brief attempt at a price recovery, dropped some more, leaving my investments (especially AMZA, which is a leveraged bet on the MLP sector) even further under water. Readers who know that I preach a somewhat modified Alfred E. Neuman ("What, me worry?") approach to market drops (as long as the securities are continuing to pump out cash) were not surprised (and indeed expected) that I would try to ignore the "paper losses" and just focus on the distributions.

Image result for alfred e. neuman picture

Savvy Senior In A Pensive Moment

I did that, but admit that it was not always easy, especially with AMZA (which was down much more than my MLP closed end funds) showing few signs of price recovery, while the argument raged (and continues) on Seeking Alpha over whether it would eventually have to cut its distribution again.

The situation has improved, but the game is hardly over. In recent weeks, the MLP market has come back, as has AMZA, to the point where the accumulated depreciation (paper loss) on my AMZA/MLP portfolio has shrunken considerably as a percent of my investment in that sector. More important, the income received from that investment now dwarfs the market loss by a margin that is growing steadily. As of today, my AMZA/MLP portfolio as a whole has collected cash distributions that are about four times the size of the market drop in the prices originally paid.

So net of the paper loss of 2.5%, the net cash return on the portfolio has been 7.9%. Even AMZA itself, which has been the biggest loser in terms of market value, is now cash flow positive in terms of the distributions received to date being greater than the accumulated market loss.

MLP Investments % Gain/Loss Accumulated Income as % of Original Investment Current Distribution Yield
AMZA -16.0% 18.2% 16.4%
CEN 10.8% 0.0% 13.0%
DSE 8.8% 9.3% 9.6%
EMO 10.7% 7.1% 10.8%
FMO -1.3% 12.6% 10.1%
Total Portfolio (Weighted Average) -2.5% 10.4% 12.4%

(No dividends received yet from CEN, which I just bought recently.)

At the current distribution rate, in another 12 months, I will have received a total of almost 23% of my original AMZA/MLP investment in cash, or about 20% net after paper losses if the market price remains steady from here on out. (That would be 10% per year.) Given where prices in this sector have been, I think a bet that MLPs and AMZA will continue to rise, or at least won't fall further, and that I will be able to pocket the cash distributions as "real" return, seems like a reasonable one.

What's the lesson in all this?

Whether or not investing in AMZA and the MLP closed-end-fund sector last year was a good idea or not at the time, it appears that holding the course and sticking with it made sense.

More important I think, is that this is a good example of how high yielding investments "buy you time" - financially and emotionally - to hang in and see what happens when they are down, rather than feeling that you have to "do something" to rectify the situation. Knowing that the group - as a whole - was cranking out cash at a rate slightly above 13% a year made it a lot easier to just sit and wait than it would have if it were a more typical growth or DGI portfolio paying only 2, 3 or 4% (or less).

To me, this is just another reason why I prefer to receive as much of my "total return" in cash, as opposed to market appreciation, if I have a choice. (Not all readers agree, as this recent comment exchange on another article makes clear.)

Of course, the elephant in the room is AMZA. My straightforward MLP funds have all bounced back quite well to prices above what I paid for them (except FMO, which still has a little bit further to go to catch up). AMZA has come back about 44% from its low, compared to what I first bought it for a year ago.

Now, as a combination of its gradual price improvement and the monthly collection of its still huge dividend, the gap between cash invested and cash collected has flipped from negative to positive and will continue to grow more positive at a pretty fast clip if it keeps paying its current rate. Even if that rate drops to the low teens, it is still a good investment, if the market price holds. So, as in March, I am still inclined to hang in there, clip the coupons and be watchful.

This mirrors my approach to other investments that have dropped but are still paying high dividends. As long as they keep paying and are digging themselves (and me) out of a negative cumulative cash hole, I tend to favor holding on, unless I believe there is some reason to believe there will be an imminent drop in distribution that their market price hasn't already discounted.

(Steven Bavaria, a former executive of Bank of Boston and Standard & Poor's, is a financial writer and consultant. As many readers know, his articles are free (as discussed here) and any readers interested in gaining access to past articles currently "behind the paywall" should make their requests known through comments or messages and he will try to find ways to unlock them or otherwise make them available. Anyone feeling compelled to compensate him is encouraged to buy his book Too Greedy for Adam Smith: CEO Pay and the Demise of Capitalism (link to Amazon) which makes a wonderful gift for all occasions. Check out all of his articles on "Income Factory" investing here on Seeking Alpha at Steven Bavaria's Articles).

Disclosure: I am/we are long CEN, AMZA, FMO, EMO, DSE.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.