FPL: A Switch From FEN Makes Sense
Summary
- First Trust New Opportunities MLP & Energy Fund has done well since our last bullish call.
- The pricing has dropped on a relative basis to its sister fund, First Trust Energy Income & Growth Fund.
- We go over the numbers and tell you why a switch makes sense.
- I do much more than just articles at Conservative Income Portfolio: Members get access to model portfolios, regular updates, a chat room, and more. Learn More »
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When we last covered First Trust New Opportunities MLP & Energy Fund (NYSE:FPL) we had a bullish outlook on the beaten down fund. The returns since then have been good and the fund benefitted from the bounce in the energy sector.
Source: Wide NAV Discount Might Power Returns
We are covering this name again today as it offers investors a good opportunity. Now, this one though is a "relative opportunity" and a kind we have not seen for some time. But first let's quickly go over what the fund does.
The Portfolio
FPL's top holdings include the large midstream companies. The fund is quite concentrated and the top-5 holdings make up more than 40% of its investment dollars.
Source: First Trust-FPL
The fund has a dominance of LP companies but some corporations also grace its roster. TC Energy Corporation (TRP) is a prominent one at the third spot. Unlike funds that invest only in the midstream sector, FPL's holdings go rather heavily into the utility sector. This is a key differentiator from funds like InfraCap MLP ETF (AMZA) and ALPS Alerian MLP ETF (AMLP). Based on the last released portfolio electric utilities make up close to 18% of the total. Gas utilities, renewable power producers and multi-line utilities add another 27%.
Source: First Trust-FPL
This is a fairly unusual setup, but it works from our perspective. The lower volatility utility sector has allowed the fund to navigate some turbulent markets far better than AMLP and AMZA.
Options
Alongside the utility exposure, FPL uses covered calls to create additional income while lowering the extra beta that leverage creates. We can see this in the contribution of option income to the total realized gain.
Source: First Trust-FPL, highlights from author
Now, we have followed the fund over time and we always saw the familiar option contracts outstanding in its holdings. However, as of the latest report, the fund was not actively deploying them.
Source: First Trust-FPL
This might be because the fund is extremely bullish on MLPs and utilities. That is certainly a valid reason to not squander upside. We will continue to check on this to see if this anomaly gets rectified.
The Opportunity
While we think FPL has a modest upside here and is certainly one of the better ways to play the sector, we are writing today to update you on a relative opportunity. First Trust Energy Income & Growth Fund (NYSE:FEN), a fund managed by the same fund-family, has almost identical holdings to FPL despite a rather different sounding name. This can be ascertained by looking at the top holdings.
Source: First Trust-FEN
We also see this in FEN's utility exposure.
Source: First Trust-FEN
Sure, subtle differences exist but the funds are very, very similar and track each other very closely. Note, that we are looking at NAV return below and not price.
Now, FEN's sudden spike higher in price has chewed up its usual large discount to NAV and it funnily trades at a 5% premium.
FEN has moved to a really high Z-score. This means that FEN is also very expensive relative to its entire history.
Source: CEF Connect-FEN
FPL on the other hand, trades at a discount and a good one at that.
The 6-month Z-score was at negative 0.98, which is quite the contrast.
Source: CEF Connect-FPL
The spread of premium/discount between the two funds reached 16.36% as of yesterday.
This is exceptionally rare territory for these two funds. While FEN has been around for longer than FPL and the 3-year total return performance on NAV is better, we see these funds' tracking each other more and more over time.
The subtle differences in their holdings could go either way in the future, even though it helped FEN in the past. Even if there is a difference, we doubt it will justify a 16.36% difference in premium. They both yield about the same at present so investors switching would not be giving up yield either.
FPL pays monthly while FEN pays quarterly. While we are indifferent on whether a fund pays monthly or quarterly, there are some with the monthly preference. Hence this is unlikely to be a negative factor for the switch that we think can be beneficial.
Verdict
FPL is a decent fund for exposure to the midstream sector. The utility exposure and the covered calls are definitely important additions that has allowed FPL to outperform some of the other funds in this sector.
The current pricing offers an interesting source of relative alpha for investors keen on looking past temporary pricing distortions. While we rate both funds as neutral, we think FPL has an edge at this point for performance over the next six months.
Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.
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This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of TRP either through stock ownership, options, or other derivatives. 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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