Energy investors seeking diversified exposure within the energy sector should consider closed-end funds, explains Roger Conrad. The editor of Capitalist Times explains the pros and cons of these vehicles and highlights three closed-end favorites.
Steven Halpern: Joining us today is Roger Conrad, editor of Capitalist Times. How are you doing today, Roger?
Roger Conrad: Good Steve, how are you?
Steven Halpern: Very good. Thanks for taking the time. Today we're going to talk about closed-end funds; the focus on the energy sector. Before we begin, perhaps you could give us an overall outlook for the energy sector.
Roger Conrad: Well, you know, things have changed in the energy sector. The way we traditionally thought about things is in terms of what's going to go on with oil prices; what's happening with natural gas prices because that's how we made money in the sector.
Nowadays, though, given the shale boom in the United States, the different techniques that are unlocking older oil fields, older gas fields, such as carbon dioxide injection, we're seeing a major boom, in terms of production in North America. The play here then becomes volume.
The best energy stocks, the best ways to play this trend of America's emerging energy independence, really, is through companies that are able to, one, increase production, or if we're talking about midstream, such as pipeline companies, the companies are able to go out and build more pipelines and sign up more customers, and get more cash flow, and increase dividends.
It's a little bit different world than we're used to seeing in energy but it's infinitely more profitable and I think rewarding for investors.
Steven Halpern: Now, I know one of the ways that you offer recommendations to your readers is to offer specific investment ideas—individual companies. Another option that you talk about in your latest research report is the market for closed-end funds, where any investor could get a diversified package of these stocks. Could you go over some of the pros and cons of using closed-end funds as a way to invest in the energy area?
Roger Conrad: Well, you know, the biggest advantage of a closed-end fund is that a management can really pick and choose what it wants to own. If you're an investor and you don't want to go out and pick and choose your own energy stocks, which, a lot of people don't, these funds offer a professional manager who's going to buy, presumably, the best stocks that he or she can find.
The biggest disadvantage-and there are several to consider—one is that closed-end funds, unlike open-end funds, they trade on major exchanges like stocks so they don't always trade for the value of the assets inside. An open-end fund will always trade for the value of the portfolio, and so, it's very liquid that way.
But a closed-end fund, it's going to depend on the market price. Sometimes it can trade at a big discount to, what's called, a net asset value. Sometimes it can trade at a big premium and it really depends on the market psychology as to when you get in.
We try to look for funds that are trading below what they historically trade for, so, in other words, if a fund that has been trading at a big premium trades in a smaller one we're more inclined to look at that than say a fund that; even a fund that's trading at a discount. That's a little bit of a wrinkle there.
|pagebreak|Another thing is that there are fees involved and there is also something of a black box. You can really get an idea of what's in a closed-end fund about once a quarter when management comes out with its report.
You're kind of taking it on faith and you're definitely counting on management to make the right decisions and, as we know, sometimes they do and sometimes they don't. Those are just a few things to keep in mind when you're looking at these.
I really think you want to look at these things; historical records, you want to look at management's record, in terms of how they performed in different environments, particularly looking at, say, something like 2008, which was a horrible environment for stocks all across the board; worse for some sectors than others.
If a manager did well in that period then I think we can count on him to do well going forward.
Steven Halpern: One of the closed-end funds that you like is called Tortoise Energy Infrastructure (TYG), which, you note, offers, sort of, one-stop exposure to the overall sector. Tell us a little more about that.
Roger Conrad: Okay, well, Tortoise is one of the older names out there. They have a very good record over the long-term, in terms of outperforming the market, picking the right stocks.
They traditionally trade at a premium to their net asset value, but again, the main thing there is not so much whether it's a premium or a discount to net asset value, it's rather what sort of premium they trade for. Is it more or less than what it historically does?
The funds that have outperformed, that do well, they will tend to trade at premiums because investors want to own them and they trust management.
That's what the premium is all about. It is something that you want to keep in mind. Now, right now, they actually—the TYG, the Tortoise Energy Infrastructure Fund, actually trades at a small discount to net asset value so I think that's very encouraging.
One other thing that I do want to point out about closed-end funds is they maintain higher yields than what you may be able to get in individual companies, but they do it by using leverage. Leverage is a double-edge sword; in other words, they borrow against the value of the portfolio and that can be a double-edge sword in a bad market.
Tortoise does use about 40% leverage. In one sense, it's not such a big deal because, again, they do have a very strong operating record and they do own a lot of very safe names, but that is something to keep in mind.
I really think you can do better with individual stocks but, I think, if you're—again, if you're looking for a fund, this is a good way to own a lot of these companies.
Another advantage with the closed-end funds is that you can put them in an IRA. You don't worry about the K1s whereas, if you own individual mass or limited partnerships, which is what Tortoise owns, you would have to file K1s—there are some tax implications. That's another advantage of these closed-end funds I think that may appeal to some investors.
|pagebreak|Steven Halpern: Now let's look at a company called Petroleum and Resources (PEO), which you point out is conservatively managed and has a consistent record. Can you expand on that?
Roger Conrad: Well, this is a fund that owns, primarily, large oil companies. It trades at a much larger discount to net asset value, about 15%. You basically have about 26% of the portfolio in ExxonMobil (XOM) and Chevron (CVX) Corporations.
This fund gives you something of a leveraged play on that by trading it at a fairly large discount and paying out a dividend based on return of capital, as well as the dividends paid by the company, so it's got a pretty strong track record.
They did change fund managers in the not too recent past; that is a consideration, but this, again, a very stable type of fund that holds primarily the largest oil companies in the world which have tended to be pretty much all weather buy and hold companies.
Of course, that begs the question why not just own Exxon, Chevron on your own, but again, if an investor wants the security of a fund and a fund that's done pretty well over time this would be a good option.
Steven Halpern: Now you also look at a third closed-end fund in this sector called Kayne Anderson Energy Total Return (KYE). Could you tell us a little about that one?
Roger Conrad: Well, Kayne is very similar to Tortoise. They own a large number of primarily master limited partnerships. They trade at a slightly higher discount, around 5% or so, but, if you look at the portfolio, it matches up fairly consistently with what Tortoise is doing.
Again, this is a very stable sector and this fund is going to produce, as long as the master limited partnerships that it holds are paying good dividends or increasing those dividends, it's going to produce fairly steady returns.
One thing I should point out, in 2008, the three funds that we've talked about did lose money that year and it was a bad year for energy. We saw energy prices fall from $150—or oil—basically $150 in the mid-summer to, at one point in the fall, barely $30 a barrel.
It was a disaster for the energy sector just like everything else but the difference was was the companies that these funds hold held together as businesses, they kept paying dividends.
They, in fact, kept growing their businesses and raising those distributions so when the market settled they were among the first out of the gate with very, very strong returns and, in fact, Kayne Anderson was up 123% in 2009.
So again, they're not immune from energy price swings but they have a pretty good track record of coming back from steep falls and again, the secret is what's inside.
We don't necessary know always what these funds own; we get, basically, a snapshot every quarter, but management does have a good track record and they do have a pretty conservative charter for running their funds.
Steven Halpern: Well, we really appreciate you taking the time to join us today. Thanks.
Roger Conrad: It's absolutely no problem; thank you, Steve.
