Closed-End Duo in MLPs

07/23/2014 9:00 am EST

Focus: MLPS

Igor Greenwald

Chief Investment Strategist, MLP Profits

Closed-end funds specializing in master limited partnerships offer a disarmingly simple value proposition: the same great businesses and the same relatively rich yields, with much more diversification and none of the tax-filing hassles, suggests Igor Greenwald in MLP Profits.

One such fund is Tortoise Pipeline & Energy Fund (TTP), which plays it safe; the fund is trading at a 9.7% discount to its recent NAV, while currently yielding 5%.

TTP is set up as a regulated investment company, so it is not taxed on its income. The tradeoff is that its direct investments in MLPs can’t exceed 25% of the portfolio. Making a virtue of that necessity, the fund has focused on the corporate parents of midstream MLPs.

To compensate up for the lower yields, TTP writes near-term, modestly out-of-the-money covered calls on oil and gas drillers and, like all MLP closed-end funds, employs leverage as well. Roughly half of the most recent distribution was classified as ordinary income, and the rest as a return of capital.

Operating cost including advisory fees were a relatively modest 1.3% of net assets last year, while debt interest bumped up the total expense ratio to not quite 2.2%.

The Tortoise has recently had most hares eating its dust with a return of nearly 19% year-to-date. One of these days, the share price could certainly play catch up.

Also on sale is Cohen & Steers MLP Income and Energy Opportunity Fund (MIE), trading at a 9.6% discount to its net asset value.

MIE is tax-efficient fund that owes no income tax on its income, and can only invest 25% of its assets into partnerships directly.

But the fund has invested another quarter of its portfolio in a subsidiary that, in turn, invests all of its assets in MLPs, giving MIE an aggregate exposure of 50% to the higher-yielding partnerships.

The fund asserts that this maneuver is legal and defensible, but acknowledges the risk that the Internal Revenue Service might disagree.

Although the fund only launched in March of 2013 and its lack of track record is likely contributing to the current discount, the managers are experienced and accomplished, with more than 15 years each of relevant experience.

Level quarterly distributions currently represent an annual yield of 6.3%. During the fund’s first eight months of operations through November 30, 86% of its distributions were classified as return of capital, and the rest as ordinary income.

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