Monthly Funds focus: US MLPs, Invesco Morningstar US Energy Infrastructure MLP UCITS ETF Dist

This month we have three fund ideas based for readers. Our main focus is on how to pick the right global equities index tracking fund – ETFs that track FTSE vs MSCI! We also put US energy infrastructure on the radar, why the dollar might be weakening, and why a currency pair ETF might be an interesting idea.

Long-term play: US MLPs

Oil prices may have fallen back aggressively in the last few weeks – WTI is at $75 and Brent at $80 – but these low prices (sparked by recession worries) won’t derail the huge investment bonanza underway in the US energy sector.

Many tens of billions of dollars are being currently invested in a range of energy infrastructure projects ranging from storage centres, through pipelines to massive LPG ports on the Gulf coast.

Even if oil prices fall back by say $5 or $10 a barrel as I expect, this huge Capex programme won’t stop. Why? Because there is simply not enough existing storage and transportation capacity to cope with the increased global demand – remember that the US industry is the big net winner from the current energy crisis.

My own core view is that even though there is a risk of stranded assets in the next 30 years, the next 10 to 15 years will prove to be a brilliant backdrop for hydrocarbon energy storage and transport.

Accessing this space is easy – the US has a very deep-listed energy infrastructure sector, mostly under the tax-efficient master limited partnership model (MLP). These MLPs are tax-efficient structures that are similar in form to our REITs and are very much focused on paying an income. Typically, these businesses own a big energy infrastructure asset such as a pipeline or storage depot, all within a tax-efficient tax wrapper. Imagine an infrastructure asset that looks and feels like a REIT.

Local withholding tax structures usually get in the way of UK investors putting money to work directly in this space but there are some UK-listed ETFs that allow participation in the US MLP sector through swap-based structures – which neutralize the withholding tax and pay out an income. This does involve one big downside – you end up paying for the swaps that neutralize the tax issue but with returns of over 50% year to date, it’s probably worth paying the price.

The sector has had a good run this year, but I think there’s much further to go long term. Here are some key numbers that provide some support for a cautiously bullish view….

• According to Global X, US diesel and heating oil inventories are at historic lows, forcing up costs for fuels vital to industry, freight, farming, and many families. Fuel inventories haven’t been this low since 1951. Diesel stocks are shrinking amid constant demand and increased exports to Europe to offset Russian supplies
• Global X reckons the current yield on MLPs stands at 7.22%, higher than the broad market benchmarks for Investment Grade Bonds (5.93%) and lower than the Fixed Rate Preferreds (7.38%), Emerging Market Bonds (8.50%) and High Yield Bonds (9.14%).
• Product inventories are running low and no near-term solution to replenish them, margins (especially for diesel and jet fuel) remain reasonably high.
• On the basis of the trailing 12-month enterprise value-to-EBITDA (EV/EBITDA) ratio, the industry is currently trading at 8.55X, lower than the S&P 500’s 11.89X. That is well above the sector’s trailing 12-month EV/EBITDA of 3.78X. Over the past five years, the industry has traded as high as 17.81X, as low as 5.76X, with a median of 10.13X

The most accessible way of investing in this space in Europe is through an Invesco ETF, detailed below. This tracks a bespoke index from Morningstar via a swap-based structure which neutralises the withholding tax. There are income and accumulation units available.

Fund Facts:  Invesco Morningstar US Energy Infrastructure MLP UCITS ETF Dist

• Ticker MLPP
• TER – 0.50% plus Swap fee 0.75%
• £155m
• 1 year 50.48%
• YTD 51.55%
• Current dividend yield 6.87%

The Index: The Morningstar MLP Composite Index is a financial index composed of US publicly traded energy master limited partnerships (“MLPs”). It targets the top 97% of MLPs by market capitalisation, weighting constituents by their total annual distributions and capping exposure to individual constituents at 10%.

Top Holdings

1. ENERGY TRANSFER UNT 9.75 %
2. ENTERPRISE PRODUCTS PARTNERS UNT 9.55 %
3. MPLX COM UNT 6.64%
4. MAGELLAN MIDSTREAM PARTNERS UNT 6.52%
5. BLACK STONE MINERALS UNT 5.77%
6. WESTERN MIDSTREAM PARTNERS COM UNT 5.38%
7. PLAINS ALL AMERICAN PIPELINE UNT 5.29%
8. CRESTWOOD EQUITY PARTNERS UNT 5.29%
9. VIPER ENERGY PARTNERS UNT 5.22%
10. CHENIERE ENERGY PARTNERS UNT 5.20%

I’m not massively bullish on this idea in the immediate short term (next few weeks), or at least until oil prices tip below $70 a barrel as a result of worries about a global; recession. If that happens my suspicion is that the Invesco ETF could see its price drop closer to £32 or even £30 a share. Long term though I think these funds are a great bet for an inflation-sensitive, defensive investment.

ETF Guide: Investing in Global Equities

This month I want to dig a little into arguably the most important single category for equity investors – global equities. Specifically, I want to map out the huge range of World Equity index trackers and ETFs available to buy and sell.

First though, lets rehearse why you might be a world equities index tracker. These index tracking funds invest in thousands of companies tracking one of three main index families – the MSCI World (which is a developed world index, the MSCI ACWI (which also includes some emerging markets) and the FTSE All World index (which covers developed and emerging markets).

The idea here is to buy a geographically diversified range of what are mainly large and mega large-cap companies, with the US market very much dominating. So, in a broad sense, this is ‘buying’ the largest slug of the global equity market in one diversified fund.

One of the attractions of this approach is that not only do you buy a very diversified basket of stocks, most of them well-known, but you are also buying into this diversified basket of stocks cheaply. The biggest ETFs in this space charge less than 30 basis points although there are a few outlier funds that charge up to 50 basis points.

I make no comment as to whether the underlying stocks in this ETFs are good value or not – my sense is that most investors buy into these funds as part of a core, long-term, market value agnostic strategy i.e they just buy and hold, ignoring the market cycles.

Arguably one could simply buy one of these world Equities funds and then add on a Global Bonds fund and have your own readymade, simple robo portfolio – the vast majority of the world’s bond and equity value in just two ETFs. Next month I will look at the World Bond indices.

In my book, you need to make two choices when it comes to these ETFs.

The first is whether you are investing in the biggest broadest indices or whether you want a style bias. This latter term means whether you want to tilt your portfolio towards say value stocks, or dividend stocks. These style or strategy indices are useful but they all come with downsides.

Assuming you go for the broadest indices possible (no style or strategy filters) you then need to decide which index family to go after one of the two global equities MSCI indices or the FTSE rival. My own personal preference is for the most comprehensive one which includes developed and emerging markets, which suggests the ACWI index from MSCI or the FTSE All World index.

As the big table below (see attached spreadsheet), there is a huge amount of choice. I would make the following observations:

• If you are after the cheapest possible access look at the Lyxor Core MSCI World tracker, ticker LCWL.
• The biggest ETF with the deepest liquidity is from iShares and also tracks the MSCI World index, ticker SWDA.
• Personally, I prefer the MSCI ACWI index which incorporates the developing and emerging markets. The best choice here is also from iShares and has the ticker SSAC.
• If you want to hedge out currency risk the best bet is another iShares tracker, this time with the ticker IWDG. This hedges out to sterling, thus virtually eliminating currency risk.
• For those investors willing to embrace riskier stocks I’d suggest looking at Mid Cap stocks, in IWFS from iShares, and Small-cap stocks, WLDS, both from iShares.
• Defensive investors might like to focus on a style or strategy index, with low/minimum volatility indices probably best. Value is also worth considering but does have more risk. My own personal favourite is the S&P Dividend Aristocrat series from State Street Spider, ticker BGDV.
• Another of my favourites is the SocGen Quality and Income indices, developed by their in-house quant guru Andrew Lapthorne. The most popular version is hedged for currency risk and has the ticker SGQX.
• In terms of best performer in 2022 so far that accolade belongs to the FTSE ALL World dividend focus index closely followed by the Global Select Dividend index.

The main index families FTSE All world The FTSE All-World Index is a market-capitalisation weighted index representing the performance of the large and mid-cap stocks from the FTSE Global Equity Index Series and covers 90-95% of the investable market capitalisation. The index covers Developed and Emerging markets and is suitable as the basis for investment products, such as funds, derivatives and exchange-traded funds. Constituents 4165 MSCI ACWI The MSCI ACWI Index, MSCI’s flagship global equity index, is designed to represent performance of the full opportunity set of large- and mid-cap stocks across 23 developed and 24 emerging markets. As of May 2022, it covers more than 2,933 constituents across 11 sectors and approximately 85% of the free float-adjusted market capitalization in each market. The index is built using MSCI’s Global Investable Market Index (GIMI) methodology, which is designed to take into account variations reflecting conditions across regions, market cap sizes, sectors, style segments and combinations. Constituents 2893 MSCI World The MSCI World Index captures large and mid-cap representation across 23 Developed Markets (DM) countries*. With 1,507 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country Constituents 1507

Trade Idea: Time has come to short the dollar

Just in case you haven’t noticed, over the last year, the US dollar has been the king of the castle. The chart below from the US Federal Reserve shows that using a broad basket of crucial currency rates on a real basis – the Real Broad Dollar Index – the US dollar is near multi-decade highs, even after allowing for recent weakening (especially against the pound). The drivers of this strength aren’t difficult to figure out: if nothing else, the dollar is a safe haven currency which benefits from increases in market volatility and concerns about economic growth.

But there must be a decent chance that the sharp increases in US interest rates might begin to level off in 2023 and that US policymakers might begin to worry more about financial stability which in turn demands balance sheet capacity and likely puts a floor under further significant QT (quantitative tightening). If that is the case then the stage may be set for continued weakening in the value of dollar, which might also benefit gold prices if investors think that the Fed will tolerate higher inflation rates.

https://fred.stlouisfed.org/series/RTWEXBGS#

In terms of funds, I have in the past suggested that the classic pairs trade of the cable £/$, long dollar, short sterling was a good trade – accessed most easily by a Wisdom Tree ETF with the ticker SGBP, which is Long the dollar and short sterling.

I think that trade has probably played out for now and you could now go for the reverse pair, short dollar long sterling ticker LGBP. My own preference is to go Long the Euro and Short the dollar – in product terms that imply the exchange traded product with the ticker LEUR (this is unlevered, the levered version at 5 times upside has a ticker SUD5). My own view is that the Eurozone has been oversold, partly because of the Ukraine war but also partly because of concerns about higher energy prices. These are valid concerns, but they are arguably overbid in my view and if the dollar weakens, the Euro may be a big beneficiary. Sterling by contrast is possibly a weaker currency because of our very idiosyncratic risk profile.

David Stevenson

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