MLPs: Winning Streak Broken, Growth Story Intact
What are you anticipating for MLPs in 2013?
2012 was the first year in thirteen years in which MLPs underperformed the S&P 500. But while MLPs’ winning streak relative to the S&P 500 may have been broken, the growth story for this sector was far from broken.
Crude oil production was up 15% in 2012, well beyond expectations going into the year. Natural gas liquids production was up 12%. Natural gas production was up 6%.
With those growing production volumes, the infrastructure build-out that we’ve long expected began to play out and should continue to play out going forward.
Why do you foresee continued expansion in this sector?
Consider the underlying oil and gas companies that have been driving increased production volumes of oil, natural gas liquids, and natural gas. At their current level of drilling activity, it’s estimated that they have over 20 years of prospective inventory remaining to drill.
So this is not a one-year story or a ten-year story. It’s a multi-decade story. As such, I feel comfortable asserting that we’re in the early innings of growth as it pertains to infrastructure and the MLPs that are helping to build out this infrastructure.
What held back MLP performance in 2012?
My feeling is that a major factor was uncertainty about policies in Washington in the fourth quarter of the year, particularly uncertainty as to what would happen with the capital gains tax rate. The expectation was that it would go up, as in fact it did, and as a result there were selling pressure on MLP stocks among some investors to potentially lock in a lower capital gains tax rate ahead of a future increase.
There were also some misconceptions out there about what an increase in the dividend tax rate might mean for MLPs. Of course, MLPs do not pay dividends; they pay distributions, which are subject to different tax treatment. Even so, this may have been a contributing factor.
How have MLPs fared so far this year?
The Alerian MLP index entered 2013 at roughly the same level that it entered 2012.1 However, distributions were 7% higher entering 2013 than they were in 2012. Balance sheets were in better shape, and distribution coverage ratios stronger than they were a year ago. Given that, I don’t think it’s all that surprising that in the early days of 2013, MLPs have performed very well relative to the S&P 500.2
TheS&P 500 Indexis an unmanaged index of 500 stocks that is generally representative of the performance of larger companies in the U.S. An investor cannot invest directly in an index.
The Alerian MLP Index is a composite of the 50 most prominent energy Master Limited Partnerships (MLPs) and is calculated using a float-adjusted, capitalization-weighted methodology.
Investments in energy related Master Limited Partnerships (MLP) securities are subject to unique risks, including the risks of declines in energy and commodity prices, decreases in energy demand, adverse weather conditions, natural or other disasters, changes in government regulation, and changes in tax laws. MLP cash distributions are generally tax deferred. Non-cash expenses, such as depreciation or depletion, usually offset income derived from an MLP’s operations. To the extent that these expenses exceed income, cash distributions are considered return of capital under current tax law. As such, they are not taxed when received. Instead, the distribution, in the form of return of capital, reduces a unit holder’s cost basis. This adjusted cost basis, in turn, results in a higher capital gain or lower capital loss when the units are sold. Of course, there can be no assurances that distributions from an MLP will be tax deferred.
All investments involve risk, including possible loss of principal. Past performance is no guarantee of future results.
Asset allocation and diversification do not assure a profit or protect against a loss.
Please note an investor cannot invest directly in an index.
Dividends and yields represent past performance, and there is no assurance they will continue to be paid in the future.
Legg Mason and affiliates do not provide tax or legal advice. Consult your tax and or legal advisor for such guidance.
The views expressed are those of the portfolio manager as of February 6, 2013 and are subject to change based on market and other conditions. These views may differ from other portfolio managers or the firm as a whole, and are not intended to be a forecast of future events, a guarantee of future results or investment advice.
This document is for information only and does not constitute an invitation to the public to invest. You should be aware that the investment opportunities described should normally be regarded as longer term investments and they may not be suitable for everyone. The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Past performance is no guide to future returns and may not be repeated. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested. Please note that an investor cannot invest directly in an index. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed and is not a complete summary or statement of all available data. Individual securities mentioned are intended as examples of portfolio holdings and are not intended as buy or sell recommendations. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors. The information in this document is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason nor any officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this document or its contents. This document may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this document may be restricted in certain jurisdictions. Any persons coming into possession of this document should seek advice for details of, and observe such restrictions (if any).
This document may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc.
This material is only for distribution in the jurisdictions listed.
Investors in Europe:
Issued and approved by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the Financial Services Authority. Client Services +44 (0)207 070 7444. This document is for use by Professional Clients and Eligible Counterparties in EU and EEA countries. In Switzerland this document is only for use by Qualified Investors. It is not aimed at, or for use by, Retail Clients in any European jurisdictions.
Investors in Hong Kong, Korea, Taiwan and Singapore:
This document is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Korea, Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore and Legg Mason Investments (Taiwan) Limited (Registration Number: (98) Jin Guan Tou Gu Xin Zi Di 001; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently. It is intended for distributors use only in respectively Hong Kong, Korea, Singapore and Taiwan. It is not intended for, nor should it be distributed to, any member of the public in Hong Kong, Korea, Singapore and Taiwan.
Investors in the Americas:
This document is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which may include Legg Mason International - Americas Offshore. Legg Mason Investor Services, LLC, Member FINRA/SIPC, and all entities mentioned are subsidiaries of Legg Mason, Inc.
Investors in Canada:
This document is provided by Legg Mason Canada Inc. Address: 220 Bay Street, 4th Floor, Toronto, ON M5J 2W4. Legg Mason Canada Inc. is affiliated with the Legg Mason companies mentioned above through common control and ownership by Legg Mason, Inc.
Investors in Australia:
This document is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827) (" Legg Mason "). The contents are proprietary and confidential and intended solely for the use of Legg Mason and the clients or prospective clients to whom it has been delivered. It is not to be reproduced or distributed to any other person except to the client's professional advisers.
This material is not for public distribution outside the United States of America.
IN THE U.S. – INVESTMENT PRODUCTS: NOT FDIC INSURED • NO BANK GUARANTEE • MAY LOSE VALUE
© 2013 Legg Mason Investor Services, LLC, member FINR A, SIPC. ClearBridge Advisors, LLC and Legg Mason Investor Services, LLC, are Legg Mason, Inc. subsidiaries.
408845 MIPX015463 3/13 FN1310964
1. The Alerian MLP Index opened on 1/3/12 at 389.93, and on 1/2/13 at 385.09. Source: Bloomberg.
2. Total return for the Alerian MLP Index for the period 12/31/12 through 3/21/13 was 16.5%% vs. 8.9% for the S&P 500.
The S&P 500 Index is an unmanaged index of 500 stocks that is generally representative of the performance of larger companies in the U.S. An investor cannot invest directly in an index.