Exchange traded fund investors who want to dive into the midstream energy market can consider a new actively managed strategy.
In the recent webcast, Midstream Marvels: An ETF Strategy for the Low-Rate Landscape, John Cusick, Portfolio Manager and Research Analyst, Miller/Howard Investments, explained that midstream energy companies are composed of the transition of a natural resource from its initial gathering to the creation of the final product. It is the infrastructure, storage, transportation, and processing of the asset itself. This sector includes pumping stations, pipelines, storage facilities, tanker ships, tank trucks, and rail tank cars.
Cusick argued that master limited partnerships and midstream companies offer a number of advantages for investors in today’s market. For example, they come with high current income relative to other asset classes with cash flows from the transportation and storage of crude oil, natural gas, natural gas liquids, and refined products. Cash flows are supported by long-term contracts and generally have limited commodity price exposure, but can have indirect exposure through volumetric changes. Additionally, MLPs and midstream energy companies have the ability to increase distributions by increasing the volumes or margins on their current systems, constructing new projects, or executing accretive mergers and acquisitions.
The sector comes with attractive yield-generating opportunities. The Alerian MLP Index showed a 8.6% yield and the Alerian Midstream Energy Index had a 6.7% as of the end of March 2021, whereas the S&P 500 came in with a 1.5% yield.
Cusick also noted that after the commodity dislocations of 2014–2015, the focus and language of the space has shifted. For example, high quality companies are now focusing on financial discipline, such as a focus on free cash flow, responsible return of capital to shareholders, and improving balance sheet metrics. In addition, midstream energy companies are further providing value to shareholders through share buybacks or repurchases, which were mentioned on company earnings calls by nearly twice as frequently as the prior year.
Midstream energy companies are trending toward better alignment with shareholder interests. Cusick highlighted improvements in stewardship of investor capital with more conservative capital allocations, higher dividend/distribution coverage, lower leverage/higher interest coverage, elimination of serial equity issuance, and improved contract structures that reduce volumetric and commodity price risk. Furthermore, they have made improvements in corporate governance through simplified corporate structures, elimination of Incentive Distribution Rights (IDRs), and increased disclosure on environmental policies and practices.
As a way to help investors capture this segment of the market, John Love, President and Chief Executive Officer, USCF, highlighted the recently launched USCF Midstream Energy Income Fund (UMI), which is sub-advised by Miller/Howard Investments, a Woodstock, NY-based, research-driven portfolio management firm. UMI, an actively-managed ETF, will apply Miller/Howard’s hallmark bottom-up fundamental research to midstream energy infrastructure companies focused on energy transportation, storage, and gathering/processing.
The USCF Midstream Energy Income Fund allocates 100% toward midstream energy, with a maximum of 25% MLPs, or approximately 20-25 holdings. Portfolio changes are driven by fundamental developments, not periodic rebalances, and stock selection and weighting are based on the best ideas from Miller/Howard research. Miller/Howard has a long track record of managing MLPs and midstream energy.
“Free cash flow has become a focus for management teams in the sector, which is viewed positively, as it provides better insight into the sustainability of the dividends that are being issued. The free cash flow yield should be attractive to dedicated industry investors and generalists,” Cusick said.
“We believe if the sector continues to see favorable sentiment, there is a potential for additional fund flows, and perhaps, even the launch of new products,” he added.
Financial advisors who are interested in learning more about a midstream energy strategy can watch the webcast here on demand.