Income Growth Advisors was founded to provide retiring baby boomers with stable growing tax advantaged income streams. We invest primarily in Master Limited Partnerships because they offer the most attractive tax advantaged income streams of any publicly traded security. This month’s letter will quantify MLPs’ yield, their under-appreciated distribution growth prospects and why MLPs’ recent weakness provides an unusually compelling entry point.
Income Growth Advisors’ five Bespoken MLP Portfolio Profiles offer investors the most versatile MLP investment strategies. The names and yields of the five profiles are: Blue Chip Total Return 7.1%, High Quality 5.34%, High Yield 10.0%, High Growth 3.58% and Aggressive 4.33%. The average yield of these five profiles is 6.03% which significantly exceeds the US 10 Year Treasury Note which yields 2.35%. Since MLPs are equities and not bonds, we focus on their distribution growth prospects and stability when constructing an income portfolio.
Our High Growth profile has eight MLPs with an average 25.5%1 estimated three year compounded distribution growth rate. Off of a base of 3.56%, that equates to a 6.99% yield in three years. To further illustrate the power of compounding and income potential of MLPs we provide a hypothetical one client asked us to review. This doctor wanted to put $1.5mm in mortgages paying 10%. We compare the 10 year total return of a 10% mortgage versus and a High Quality MLP portfolio with its growing distributions, (see PowerPoint page 16 http://bit.ly/IGA_OCT_Presentation) and MLP portfolio really outperforms.
Lastly, investment icon Jimmy Rogers has said that MLPs have bottomed.2 Rogers is a legendary investor known for calling several major market turns.
Buy MLPs Now
Jeffrey Saut, Chief Investment Strategist for Raymond James & Associates cited a noteworthy investment guru Jimmy Rogers. We agree with both of these talented professionals and their arguments.
While we defer to Jimmy Rogers’ talent, our record calling market turns in the MLP space is nothing to dismiss. See our January 2016 and March 2016 letters:
Those letters preceded our 76.6% trailing twelve month return as of March 2017 which was thoughtfully noted in Barron’s by Amey Stone: http://bit.ly/Tyson_Halsey_Barrons
MLPs are significantly underperforming the S&P 500. This condition sets up for a technical reversion to the mean and we believe the fundamentals support that conclusion. The two charts below illustrate the recent underperformance of MLPs to the S&P 500.
The performance table below shows the considerable underperformance of our MLPs performance to the S&P 500 year to date and in the last one, three and five years of -25.04%, -15.67%, -17.23% and -9.15% respectively within the period where we still outperformed the S&P 500 by 8.61% annually over the last 16.75 years.
Equities are near historic high valuations, though not as high as 2000. Bonds are near historically low yields, though not at the lows of July 2016. What this tells us if fundamentally and quantitatively, is you can buy MLPs with unusually high yields and near bear market valuations. While we can never call the precise bottom, the market forces are suggesting that MLPs are at an extreme undervaluation relative to stocks and bonds and are primed for a technical reversion to the mean.
The performance chart below shows the significant outperformance of our SMA accounts to the Alerian Index and the Alerian MLP ETF (AMLP). The chart also shows the long-term outperformance of MLPs to the S&P 500 since 2001 and the recent relative underperformance of our MLP holdings which we believe will soon reverse.
IGA’s Bespoken MLP Portfolio Profiles:
How do you best play this opportunity in MLPs? We think our Bespoken MLP Portfolio Profiles offer several versatile strategies to suit your tastes. Our five profiles are:
- Blue Chip Total Return: larger capitalization MLPs with solid distributions and growth prospects,
- Highest Quality: the safest MLPs with the lowest risk profile,
- High Growth: those MLPs with the highest distribution and cash flow growth prospects.
- Aggressive Growth: the MLPs with the highest return profiles, but whose risk profiles (balance sheet and business risks) are above average.
- High Yield: the highest yielding MLPs which do not appear at imminent risk of cutting their dividend.
This month, we are highlighting our Bespoken High Growth MLP Portfolio Profile. The following chart illustrates the power of compounding on distribution growth. MLPs’ estimated returns are generally calculated by adding the distribution yield and the three-year distribution growth rate. In the chart below, we start compounding a 5% distribution yield at 25% for five years, approximating the High Growth distribution and yield profile. We then compound that distribution growth rate at 10% for the next 10 years. At the end of 15 years this hypothetical high growth MLP portfolio could yield 39.5%.
The Value of Distribution Growth
MLPs behave like bonds in that they trade with prevailing interest rates. Since 39% is a tremendous yield on your original capital to receive each year, your portfolio will likely multiply to three to five times it original value over this period.
On a $100,000 portfolio your income would grow from $5,000 a year to $39,580 a year. Since MLPs won’t yield 39% in 15 years, they will adjust through price appreciation and your portfolio could grow to nearly eight times or $800,000, all the while you have been collecting an attractive tax advantage income stream. While this is an aggressive example, we have more conservative examples in our attached monthly PowerPoint presentation.
We believe, investors have and continue to fail to appreciate the value of a compounding distribution yield. In the wake of the 2014-16 bear market in oil and MLPs, investors can be forgiven for not believing a high growth scenario for MLPs; however, with good security selection and a new phase to the US hydrocarbon renaissance, even half the above hypothetical could provide a meaningful source of future tax advantaged income and wealth.
For income and total return minded investors, we offer our MLP SMA strategy through our prime brokers US Trust/Bank America/Merrill Lynch, Interactive Brokers and Folio Institutional. Given the improving domestic energy market and compelling income prospects this is an excellent time to allocate to MLPs. MLPs offer a clear pathway to an attractive, growing and tax advantaged income stream ideal for retirement and investment diversification.
If you have any interest in discussing specifics regarding the strategies outlined in this letter, please feel free to contact us.
Tyson Halsey, CFA
- Barclays research which estimates three year CAGR distribution growth.
- Jeffrey Saut, “Gleanings” Raymond James & Associates Sept. 27 2017, quoting Jimmy Rogers