This is part three of a five-part interview with John (Jack) E. Leslie III, CFA Portfolio Manager for the Miller/Howard Income-Equity Fund. The interview is part of ValueWalk’s Value Fund Interview Series.
Miller/Howard Investments Inc. is an independent, SEC registered investment firm with over two decades’ experience managing equity portfolios for institutions and individuals in disciplined, dividend-focused investment strategies.
Jack Leslie has over 30 years of experience in the money management industry and before joining Miller/Howard in 2004 Jack was a portfolio manager at Value Line Asset Management, M&T Capital Advisors Group (Division of M&T Bank), and Dewey Square Investors (Division of UAM). Jack has been interviewed by The Wall Street Journal, Barron‘s and Forbes Online. Jack has appeared as a guest on thestreet.com and After the Bell on Fox Business.
The interview has been divided into five parts and will be downloadable as a PDF at the end of the series. So stay tuned.
Dividend investing with Miller/Howard Investments [Pt.3]
Continued from part two……
You recently launched the Miller/Howard Income-Equity Fund (MHIEX) why did you decide to launch this fund now and what makes it stand out from other equity income funds?
We’ve been providing our quality income and growth of income approach to high net worth and institutional investors for 25 years. Many of them have asked us about a mutual fund wrapper for many years as separately managed accounts typically have a $100,000 minimum account restriction. So for us, it was a matter of increasing access to our dividend management to a greater number of investors. It is the same approach and portfolio as our managed account portfolios.
I should also mention that we have managed this strategy with ESG screens since its inception in 1997. In addition to exclusionary ESG screens such as tobacco, firearms, gambling, human rights, and labor issues, we focus on shareholder engagement. We have a track record of engaging with companies to enact change as we prefer engagement over divestment. Our success in this area was recently recognized by Morningstar with a five globe ESG rating. This fund was ranked #2 out of 465 ranked value U.S. mutual funds by Morningstar on their sustainability score.
One of the sectors Miller/Howard has a large exposure to is, MLPs. This sector has come under pressure recently. Do you still believe MLPs are a good investment for income investors and where are you finding the best, most sustainable yields today?
We’ve been investing in MLPs since 1997. If you go back to the three-part formula I mentioned earlier – high quality, high yield, and dividend growth – MLPs are the poster child for that approach. The MLPs in our portfolio own long-life assets with a high percentage of fee-based business, meaning revenues are derived from multi-year take or pay contracts. They consistently pay a high yield and also have grown their yield in the 6-8% range annually. There are two factors I would highlight that have recently impacted the sector. First is, the overall damage done to the energy space by falling crude oil and natural gas prices. This in itself was a result of what we would call the shale revolution as new technologies led to a boom in energy production in this country. The excitement caused by the shale revolution resulted in a lot of money entering the space – including the buildout of our energy infrastructure. Infrastructure in some parts of the country did get overbuilt. But I should point out, there is still a need for energy infrastructure in other parts of the country, so good opportunities exist for the right MLPs. This increase in investment likely resulted in some of the big distribution growth numbers we saw from MLPs just a few years back.
Valuations for MLPs also got a bit extended. A big reason for this is the overall low-yield environment and investors’ search for yield. MLPs have historically been a haven for the high-net worth investor who were mostly attracted to MLPs for their tax-deferred income. Investors became limited partners of the MLP and would have to file a K-1 tax form each year. Retail products began appearing a little over 5 years ago that offered a way to invest in MLPs while also blocking the K-1 paperwork. These retail products have their own issues but it doesn’t seem to have slowed down investment in this space. By most accounts there was over $30 bil that entered the MLP space through these new products over a very short period of time. It would be an understatement to say that the market had difficulty in absorbing this influx of assets. Keep in mind that the MLP space is fairly confined. If you combined the 100 + energy MLPs into one entity, it would not even be the biggest publicly traded company.
All this is to say that the MLP space has become very volatile – far greater than what we had seen in our first 15 years of investing in MLPs. We’re talking about price volatility. The income picture has become more stable and for income investors, we see MLPs as offering good value. Even though they are over 50% above their lows of February 2016, we consider them to be in the fair value range (reminder they are still 30+% below their high while the S&P trades at an all-time high). However, in the current low-yield environment, and considering the attractive assets owned by the MLPs, it would be reasonable to expect MLPs to trade at a premium so we certainly see upside in prices from here. We continue to evaluate our MLP exposure at this time due to the somewhat extreme price volatility, the increasing clarity on the income and income growth side look compelling. You can buy into a 6% yield with 4-6% growth of yield as long as you can tolerate the sector volatility.
As for the most sustainable yields in the space, we think you need to be very selective as roughly 35 of 120 MLPs have cut distributions over the past 12 months. Some of the factors we look at are growth in distributable cash flow, debt levels and maturation profile, the current Incentive Distribution Rights structure, the amount of fee-based contracts in their revenue stream, the quality of their counter-party relationships, and their current valuations.