CFA North Carolina is hosting Tortoise Capital Advisors, an MLP investment adviser established in 2002 with approximately $9.1 billion in assets under management today. Tortoise will be leading three discussions on trends in North American energy infrastructure, in Charlotte, Winston Salem and in Raleigh. Feel free to visit CFA North Carolina for details if you would like to attend.
Like Tortoise, we believe pipelines offer a high quality and predictable means of gaining exposure to the growing investment in our nation’s energy resources. The resilient nature of these real assets, combined with attractive and growing yields, offer a compelling opportunity in an uncertain world where high quality income is difficult to come by. In this series of posts – excerpts from our next Broyhill Letter – we will explore this opportunity in detail, beginning with an introduction to Investing in Infrastructure today:
Investing in Infrastructure
“A successful society is characterized by a rising living standard for its population, increasing investment in factories and basic infrastructure, and the generation of additional surplus, which is invested in generating new discoveries in science and technology.”
– Robert Trout, “The Iron Man of Radio”
Oxford Dictionaries defines infrastructure as the basic physical and organizational structures and facilities (e.g. buildings, roads, power supplies) needed for the operation of a society. Broyhill characterizes an investment in the “operation of a society” as a safe bet amidst a hazardous macroeconomic backdrop. Providing access to essential natural resources required to uphold or improve standards of living are among the most fundamental of societal services.
Sources trace the origin of the word “infrastructure” in the English language to 1927, but the military use of the term achieved prevalence after the formation of NATO in the 1940s, and was later adopted by urban planners in its modern sense around the 1970s. The term came to prominence in the United States in the 1980s following the publication of America in Ruins, which kicked off a public-policy discussion around the nation’s “infrastructure crisis,” instigated by decades of insufficient investment and inadequate maintenance of public works.
Today, infrastructure may be owned and managed by governments or by private companies, but in the economic context of an extended debt deleveraging, policy makers can no longer resort to the Rooseveltian Recipes reliant on massive borrowing to fund infrastructure projects without regard for the long-term fiscal consequences of such policies. Even so, existing assets must still be maintained and repaired, and new assets must be built to ensure the continued competitiveness of the western world. Given that the required investment is enormous and the traditional provider of that capital – government – does not have the resources to do that anymore, private sector interest has grown considerably in recent years.
According to Preqin, over $175 billion has been raised by banks and managers for private infrastructure funds since 2004 with pension funds being the leading investors in the asset class. The OECD estimates that there will be a worldwide need for as much as $30 trillion of infrastructure investment in the next two decades. In other words, there is considerable room for additional capital flows considering that average allocations to the asset class only represent one percent of pension assets today. Interest is growing for obvious reasons – infrastructure is a natural fit for large pensions and sovereign wealth funds with long-term liabilities. These institutional investors need to protect the value of their portfolio from the toxic consequence of currency debasement and inflation, while minimizing volatility in order to maximize the recurrent cash flows to beneficiaries. As a result, infrastructure is an ideal investment that provides tangible advantages: long duration real assets; high and growing distributions with natural inflation hedges; and statistical diversification which reduces overall portfolio volatility.
Enter The Master Limited Partnership
Although long recognized as an attractive asset class for institutional investors, access to infrastructure investment has been historically difficult to achieve for individual investors, particularly in the United States, where the majority of infrastructure is government owned and controlled. Fortunately, a liquid alternative now exists. Domestic energy infrastructure assets are often organized as Master Limited Partnerships, or MLPs, which are listed companies that own, manage and operate qualifying assets. The MLP structure enables these firms to utilize the tax advantages of partnerships. Shares trade like a corporate stock, but only pay one level of federal income tax so they are not subject to the double taxation of public companies.
MLPs provide investors with a direct pathway to infrastructure investment. Traditional MLP assets include intrastate pipeline systems that take products to storage, regulated interstate pipelines that go across state borders, and the gathering and processing systems that take natural resources from the wellhead to the distribution point. These pipelines typically collect steady fees with long-term contracts, regardless of the types of and prices for the commodities that pass through the pipes. Upstream exploration and production MLPs find long-lived oil and gas assets after they have had a drop in production. These assets have a long tail, which means a slow decline in future production and steady cash flow. Downstream MLPs are the refining assets and chemical plants.
By confining 90% of their income to these specific “qualifying” activities, MLP units are able to trade on public securities exchanges without entity level taxation. As of March 31, 2012, there were 81 publicly traded MLPs with two classes of ownership – general partners (GPs) and limited partners (LPs). GPs manage the partnership’s operations, receive incentive distribution rights (IDRs), and generally maintain a 2% economic stake in the partnership. LPs are not involved in the operations of the partnership and have limited liability, much like the shareholder of a publicly traded corporation.
We’ll investigate the competitive dynamics of the industry, in addition to outlining our investment thesis for the industry, tomorrow.