Libby F. Toudouze Of Swank Capital Explains Master Limited Partnership Investing Strategy And Identifies MLPs With 6% To 7% Yields With Growth To Offset Inflation
December 1, 2010 - The Wall Street Transcript has just published TWST Investing Strategies Report offering a timely review of the Asset Management sector. This Special Report contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. Please find an excerpt below.
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Libby F. Toudouze, Partner and Portfolio Manager, has 26 years of experience in investment management. Before joining Swank Capital, she established and ran a family office, where she developed investment policies, created an asset allocation framework and analyzed investments. Ms. Toudouze worked for seven years in private wealth management at J.P. Morgan, Morgan Stanley and Bank of America. She was an Analyst, Trader and Portfolio Manager at hedge fund Paragon Associates. She also worked on the institutional trading desk at Merrill Lynch and on the floor of the NYSE. Ms. Toudouze earned her BBA and her MBA from Southern Methodist University.
TWST: Tell us about MLPs as an asset class. They have become more popular over the last few years, but there are a handful of investors who may not be familiar with them.
Ms. Toudouze: MLP stands for master limited partnership, and really these are publicly traded equities that trade like any other mid-, small- and large-cap stocks. They trade on the major exchanges, New York, Nasdaq and AMEX.
The difference is instead of being a corporate structure, it is a partnership structure, and there are some advantages to that because - the number one advantage is you don't pay corporate taxes, so really any business would love to have that structure. However, it is really limited to those that are involved in natural resources - that is basically the extraction, transportation of a depletable resource. These MLPs qualify to have that preferential structure, but that structure is a pass-through, and it will pass through tax-advantaged income, which is obviously a huge benefit. But the tradeoff is you get a K-1, and that has kept some people from being in this asset class. That has changed now that there are many different structures out there. For example, the ETN, the Cushing 30 ETN, you don't get the tax benefits, but you also don't have to deal with K-1; you get a 1099 that the mutual fund, Cushing MLP Premier Fund, the closed-end funds all get.
So we have expanded the vehicles to allow really any investor to gain exposure to this space. And the reason people want and they are starting to hear more about this asset class is that here is a publicly traded equity that's got an underlying business that has little economic sensitivity, right? Because we have to have this - if we don't have the oil and natural gas getting from the fields to the end user, we don't drive our cars, we don't have lights, we can't run our computers. So this is a necessity business, so little economic sensitivity. And you have that publicly traded equity that gives you a high level of income, especially in today's environment - 6%, 7% cash distribution - and which may or may not be tax advantaged, depending on the structure you have. You may or may not receive those tax advantages. And then it also gives you a growth component, and that growth component is really predictable over the next two decades. Why? Because we have found in the United States a large number of, over the last decades, of new sources of energy - specifically natural gas - over the last four or five years, and then more recently actually domestically oil.
And as in the 1920s, in Cushing, Okla., when you find these new sources, there is not the associated infrastructure; it has to be built. So the natural gas association estimates that between oil infrastructure and natural gas infrastructure over the next two decades, we need $200 billion of that infrastructure to be built to just handle the new sources that we have found that exist today to get that gas and that oil from the field to the end user. And so you really have great vision into the future, as I said, multiple decades for growth and income, because that's what they do. Now as investors look forward, this nice, predictable growth component provides somewhat of an inflation hedge. I don't know when it's going to come back, but it will.
And when interest rates go up - and again, don't know when they are going to go up, but they will - that growth rate, which over the last decade has always grown higher than CPI, will provide you a nice hedge against inflation and a nice cushion against rates going higher, unlike fixed income. BBB bonds are probably the closest thing you could find in yield to MLPs today. But remember, there is no growth on those bonds. When rates turn up, those bonds are going to get hurt pretty good; the MLPs have that protection.
And now institutions - pensions, endowments, foundations - as they struggle because their capital bases are down, and they need income but they don't want to sacrifice growth to get income, here is a publicly traded equity that gives you both. We think we are at the beginning of a really exciting cycle in MLPs. We are in the third inning here. Again, very similar - I used the REIT analogy before - very similar to the way the REIT asset class was 10 or 15 years ago, when people really didn't know what a REIT was, and it's become one of the major asset classes.
We believe MLPs, with $230 billion cap today, are going to become, have become, an asset class and will continue to grow. Again, we have to have this infrastructure. If you are a big energy company, you don't want to have this midstream business - it's the boring 10% to 12% ROE business. You want that sexy exploration production business giving you the 70% ROE; that's where you want to spend your capital. You are delighted to sell the assets you have in the midstream segment.
We have seen many examples of this recently, such as Chesapeake (CHK). Chesapeake is one of the biggest big E&P companies in the natural gas area in the U.S.; they spun out their midstream business, all their infrastructure. Why? Because the MLP structure is the most efficient way and most competitive way to hold those assets. And so we think that a portion of the $300 billion of energy infrastructure that still sits in big E&P companies will come out.
And you have the organic projects, the greenfield projects for the new sources of energy, that will have to have infrastructure. So pretty exciting time in this space. And Jerry Swank, who is a pioneer in the MLP sector, saw this back in 2003. I think with his energy background and fixed income background, that allowed him to identify an asset class, which at that time maybe was $20 billion and a dozen-plus public companies, that was going to be something big. Jerry put together the Swank MLP team, focusing on energy experience and MLP knowledge to take advantage of this.
TWST: And now there are somewhere in the neighborhood of 75 MLPs or so?
Ms. Toudouze: That's correct, four of which have come public this year. And you will probably see a like amount at least coming public next year. So continue to see growth.
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