AMZA And MLP Funds: Still Clipping Coupons And Waiting

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Includes: AMZA, CEN, DSE, EMO, FEN, FMO, KYN
by: Steven Bavaria

Summary

AMZA and the MLP Funds have been teasing investors all year, with occasional signs of uplift, but never quite getting into orbit.

But we are paid well to wait and be patient, and cash distributions received are almost twice the market losses - "paper" and realized - on our MLP portfolio.

There is no reason to doubt that eventually the market will again recognize the essential character of the infrastructure MLPs provide.

And value them accordingly.

Twice this year I've written articles raising the question of what to do with AMZA and my other MLP funds (articles here and here). Now as I prepare to review my entire Income Factory portfolio for the third quarter Savvy Senior update (due out next week), I think it is worth a separate review of my position in the AMZA/MLP segment, given how much attention (both positive and negative) this asset class continues to get, especially InfraCap MLP ETF (AMZA) .

While generating cash, the funds had been a disappointment as far as maintaining or increasing their market values, despite the widely held belief that the MLP sector was "down but far from out" in terms of its long-term role as a provider of critical infrastructure and the cash flows that should go with that in a rational economic universe.

In my previous articles, and again in this one, my approach is not to take a position on whether MLPs in general and AMZA in particular are attractive as new investments but rather to assess what is the best course for someone who already has a position. (The classic Lewis and Clark dilemma: You're halfway across the river that's turned out to be deeper and more dangerous than you envisioned. Do you turn back, or keep on walking/swimming?)

My attitude was and still is that since the cash distribution continues to be strong and more than offsets the market price depreciation, "staying the course" - for now - is not a particularly risky strategy.

(This, as discussed before, is a real advantage in high yield investing generally: that your "river of cash" is a buffer that allows you to wait out flat or down markets without worrying so much as investors who have to watch more "inert" investments just sit there or fall in value while producing little or no offsetting cash income.)

I noted two months ago that my overall MLP fund investments (including AMZA, which constitutes about a quarter of the MLP total), were under water (i.e. had a "paper loss" or "unrealized depreciation") in terms of market value by about 2.5%. Offsetting that, and making me feel more positive about the whole thing, was the fact that the portfolio was cranking out cash at an annual rate of 12.4%, and that cash distributions received up to that point were over 4 times as much as the paper loss.

AMZA, unfortunately, has more than pulled its weight in generating that paper loss. But it has also been paying an out-sized distribution that had just recently surpassed the market value drop (i.e. cash distributions received exceeded the paper loss). So the "trend seemed to be our friend" with cash distributions slowly but steadily offsetting the accumulated market depreciation.

That friendly trend has become a bit cooler in the last few weeks with AMZA having given up some of its market gains of a few weeks back and the rest of my MLP funds - CenterCoast Brookfield MLP (CEN), Duff & Phelps Select Energy MLP (DSE), ClearBridge Energy MLP (EMO), Fiduciary Claymore MLP (FMO), First Trust Energy Income (FEN) and Kayne Anderson MLP Midstream (KYN) - also showing little of the long-expected recovery. (FEN and KYN I have just recently added, so they haven't had a chance to start contributing cash distributions yet, but with yields of 10.4% and 10.7%, and discounts of -4.1% and -7.25%, respectively, I think they will be good additions to the portfolio.)

But the overall numbers are still positive, with total cash distributions received, and still being pumped out at a distribution yield of 12.3%, exceeding the market price depreciation by a ratio of 1.8 to 1.

The following table shows (1) the market value gain or loss, (2) total cash distributions received, (3) the net gain/loss (i.e. the difference between the two) for each fund, and (4) the current distribution yield.

FUND Symbol Market Value Gain or Loss as % of Cost Total Dividends Received As % of Cost Total Gain/Loss (Including Distributions) as % of Cost Distribution Yield
InfraCap MLP ETF AMZA -19.23% 20.50% 1.27% 17.40%
CenterCoast Brookfield MLP & Energy CEN 2.90% 1.93% 4.82% 12.97%
Duff & Phelps Select Energy MLP DSE -1.60% 9.59% 7.99% 9.76%
ClearBridge Energy MLP Opportunity EMO -1.13% 9.80% 8.67% 11.06%
Fiduciary Claymore MLP Opportunity FMO -5.96% 15.02% 9.07% 10.42%
First Trust Energy Income & Growth FEN -0.46% 0.00% -0.46% 10.38%
Kayne Anderson MLP Midstream KYN -0.57% 0.00% -0.57% 10.74%
Total Portfolio -5.13% 10.06% 4.94% 12.3%
(Weighted Average)

Admittedly, that current 1.8 to 1 ratio is not as impressive as the 4 to 1 ratio of dividends received to "paper loss" reported two months ago, and is explained by the slippage in market price by AMZA and the other MLP funds in recent weeks. But the fact that (1) there seems to be no apparent economic reason for the recent price slippage, and (2) the underlying cashflows appear to be strong, encourages me to hang in there for the moment.

@Hinds Howard, who writes as "The MLP Guy," said in an article the other day (emphasis mine): "Like Tiger [Woods], MLPs probably will not regain their former dominance. Their streak of beating the S&P 500 for 11 straight years from 2000 to 2011 isn't likely to happen again. But, midstream fundamentals and financials are improving, and it seems inevitable that midstream stocks will make a sustained comeback."

Given where these funds currently are, I will be quite happy with a "sustained comeback" even if the MLP sector never achieves its "former dominance." That's particularly true if our entry points in these funds - spread over the past year - turn out to have been during a historically depressed period when we look back in a few years. Even a smaller comeback, where the funds make up some or most of the market depreciation, and continue to crank out their current 12%-plus average distribution levels, will satisfy me that patiently holding on is the right decision.

Let me add a final thought about downside risk, which readers know is an important topic to me and drives much of my strategy about diversification and asset class selection (e.g. credit versus equity, as in this article).

Since AMZA is probably our most controversial holding and the primary concern expressed about it is the sustainability of its generous 17% distribution, it seemed prudent to stress that and see how it affects our strategy. If we assume a drop in AMZA’s distribution to 12%, which would be more in line with the higher distribution end of the MLP fund spectrum, the impact on my entire MLP portfolio would be to drop the portfolio distribution yield from 12.3% to 11.2%. If you cut the AMZA payout to 10%, the entire MLP portfolio yield would drop to 10.8%.

That suggests to me that AMZA’s above average yield is icing on our MLP portfolio cake, but the cake itself would be tasty even if AMZA merely passed through its own portfolio’s distributions and added none of the cash flow “sizzle” that it currently adds (or hopes to add) through its leverage and options strategies.

Bottom line, we will continue to wait and watch, while clipping our coupons.

Thanks to other writers, especially @Trapping Value, @Todd Akin, @Treading Softly, @Hinds Howard and @The Fortune Teller for their helpful articles on AMZA and the MLP space generally.

Steven Bavaria, a former executive of Bank of Boston and Standard & Poor's, writes extensively about his high yield “Income Factory” investment strategy. You can "follow" him and/or check out his other writings on his personal profile page here on Seeking Alpha (link: Steven Bavaria's Articles).

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

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.

Additional disclosure: These funds are all part of my Savvy Senior "Income Factory" portfolio