One analogy that comes to mind when thinking about the market in a big picture sense is that of all-out war. Every market participant wants to win that war and generate better returns than their competitors and make no mistake, all the other market participants could care less if you lose the war you are fighting against them. There are two sides to every single trade. Every market participant must also battle with themselves, internal fear and greed, for example, but also the constraints that arise from the size of their “armed forces.”
The size and breadth of a market participant’s armed forces parallels their Assets Under Management (“AUM”). Every investor should consider the size of their armed forces when coming up with their battle plan for the market. There are very large investors with very large AUM and there are very small investors with essentially microscopic AUM. Both should take different approaches in their strategic offenses.
On February 23, 2013 Barron’s published an article titled “The New MLP Landscape” (if the link doesn’t work due to the pay wall search for it using Google). The article interviewed two asset managers focused on the MLP space: Kyri Loupis of Goldman Sachs Asset Management and Chris Eades of ClearBridge Investments who together control about $9 billion of MLP focused funds. The sheer size of assets / armed forces that they control should immediately register to you that they are important. In comparison, the total AUM of every single person to ever read this post is essentially zero when compared to $9 billion. Thus, we are the guerilla fighters in a war dominated by large well-funded, well-equipped adversaries.
Conveniently in the article both large asset managers were gracious enough to discuss some of their “favorites” in the space (highlighted in yellow in the chart below). The chart shows the MLP landscape sorted by Market Capitalization (the 9 favorites from the article are OKS, MWE, ACMP, NGLS, WES, GEL, TLLP, OILT and DKL):
Asset managers get compensated in part based on the size of their total assets being managed, thus they are always trying to grow that amount, because hey, who doesn’t want to get paid more money? As Mr. Loupis and Mr. Eades increase their already very substantial AUM they will need to deploy the new funds into MLPs and their list of 9 favorites is probably an area where they will focus. All 9 of them are decent MLP investment choices (please see their comments on each in the article).
The size of their funds compared to the size of some of the MLPs named could provide opportunities. The smaller the size of the MLP, the harder it will be for them to add to their positions without creating upwards pressure on the unit price. Of course nothing is certain, Mr. Loupis and Mr. Eades could have specifically chosen the names they mentioned because they are already at their stated concentration limits for investing in those names. The smallest of the group, Delek Logistics Partners, has a market capitalization that is only around $650 million. Hypothetically if they can’t go over 10% ownership concentration in a single company then $65 million out of $5 billion is only ~1.3% (so in this hypothetical example their size works against their performance by limiting how much they can focus on their best ideas). If this concentration limit theory is correct then they may be aggressive buyers during future equity raises for any of the names discussed, which could manifest itself in slightly better issuance pricing (less of a discount to get the deal done) and better post deal trading in the names.
The guerilla investor can use that to their advantage. Like a lone sniper, I am now stalking those names to possibly deploy my small armed forces into battle in front of any comparatively large offensive that could materialize thanks to Goldman Sachs or ClearBridge.
If you know the enemy and know yourself, you need not fear the result of a hundred battles. If you know yourself but not the enemy, for every victory gained you will also suffer a defeat. If you know neither the enemy nor yourself, you will succumb in every battle. – Sun Tzu, The Art of War
My purposely chosen battlefield is the MLP landscape, have you chosen yours or has it chosen you?
Note: Paid subscribers please be on the lookout for rankings on the 9 names in this week’s Weekly Snapshot report.
I’m not sure but I don’t think so, perhaps they have figured out that they can generate enough returns in the space to also pay the UBTI taxes and still have an asset class that fits into their aggregate portfolios.
Has something changed related to UBTI risk for pension fund ownership? Without some change here, my assumption was that pension funds were limited to i-shares and the LNCOs of the world. Maybe the funds can purchase MLP Etfs and indirectly boost inflow that way?
We’ll see but a following tide from Pension Funds increasing exposure to MLPs would definitely be very helpful. On MPLX it seems like the market is pricing in a very, very high distribution growth rate, one I would expect is substantially higher than the dividend growth rate of JNJ.
It sure looks like the yields are going to come way down. Some are already so low they are starting to compete with government paper. The current yield on MPLX is 37% lower than JNJ !
Thank you sir and I completely agree on your list of reasons why the large fund managers are benefitting. There was also another recent Barron’s article that mentioned that the Ohio Police & Fire Pension Fund was having a bake-off for an external MLP manager to run $645 million for them in the MLP space, which is a 5% allocation of their total funds (http://blogs.barrons.com/incomeinvesting/2013/02/19/mlps-beating-s-three-reasons-why/).
The U.S. pension fund space is astronomically large, if they all make a strategic shift to put 2% to 5% of their assets in MLPs (sometimes herding instincts kick in), things will get very, very interesting…
Great insight…among your best posts so far. Never dawned on me that these CEFs are bigger than many of the companies they are stalking. This must mean a large number of investors are interested in the space, but reluctant to buy partnerships directly. The funds are likely benefitting from a combination of K-1 fear, IRA money, and desire for diversification.