I’ve written extensively about the energy sector in recent months given what I believe to be longer-term tailwinds favoring the sector. The midstream segment is particularly interesting, as this is where the infrastructure side lies. Companies here offer exposure to the energy market with often lower volatility than upstream producers or integrated majors with downstream operations. Many operate in regulated environments with stable cashflows that support healthy dividends. If energy demand continues to grow, as it is expected to, especially with the slower but steady shift towards cleaner energy sources that will require new infrastructure, this subgroup of the energy sector should do particularly well.
So how do you access it? Either actively or passively. Let’s address one of the more active funds out there – the USCF Midstream Energy Income Fund (NYSEARCA:UMI). This ETF seeks to provide investors with a consistently high level of current income, with capital appreciation as a secondary objective. The fund is managed by USCF Advisers, LLC, with Miller/Howard Investments, Inc. the sub-adviser. It uses a bottom-up fundamental research process to evaluate midstream energy infrastructure companies primarily using metrics such as income, growth of income, distribution coverage, leverage, direct-commodity price exposure, and contract quality.
ETF Holdings
UMI includes a diversified portfolio of midstream energy companies. The fund does have high concentration at the top, with the number one position having a near 10% weighting. On the one hand, I like this. You want to see an active fund take high conviction bets. On the other hand, it obviously introduces a whole new layer of risk as a diversified basked gets driven by company specifics.
The holdings help produce a nice 30-Day SEC yield of 5.22%, a nice kicker if you prefer more of your total return to come from distributions as opposed to capital appreciation. About 24% of the fund is made up of MLPs (master limited partnerships) which is where that income comes from, and thankfully the fund is able to distribute without K-1s.
One thing worth noting is that the fund is trying NOT to be as tied to spot energy prices. From an active perspective, the appeal is that the fund’s focus is on companies that have long-term contracts. Yes – this should bring volatility and uncertainty down, but also means the fund won’t be as levered to rising oil prices in the near-term if that’s your bet.
Peer Comparison
The big players here are the Alerian MLP ETF (AMLP) and Global X MLP & Energy Infrastructure ETF (MLPX), both focused on midstream energy infrastructure. These are passive, whereas UMI has more strategic allocation, and this flexibility increases the opportunity for higher returns. When we look at the performance side of things, UMI ranks second, outperforming AMLP but underperforming MLPX. Overall, it’s unclear if the active management really adds value.
Pros and Cons of Investing in UMI
Things I like – accessing the midstream infrastructure side of the energy supply chain is appealing. Although cyclical, it can be less volatile than exploration and production companies (the upstream segment) since more of its returns come from the fee for use of pipelines and other infrastructure. This long-term nature of contracts and revenue streams for many of the firms magnifies these benefits and provides reliable cash flows and a healthy distribution yield.
In addition, UMI’s active management provides the opportunity to shift allocations strategically and to potentially enhance returns as market windows open. The fund’s goal of high current income holds broad appeal for income-seeking investors, with its second goal of capital appreciation seeking to fuel growth.
But investing in UMI also carries with it certain risk factors. Although the energy sector balances the fund in many ways, as the entire commodity industry behaves in a boom-and-bust fashion, midstream companies – similar to energy companies themselves – can be susceptible to commodity price volatility and market movements. Instability in regulations, environmental concerns and shifts in energy demand affecting utilities can also weigh on the performance of midstream infrastructure companies. Also, the high current income focus introduces the risk of interest rate sensitivity, as interest rates affect bonds and other fixed-income-generating assets disproportionately. Interest rate hikes tend to cause returns for income-generating assets to drop.
Conclusion
In summary, UMI looks like a good fund. I like the midstream space. The issue is more whether the active side of the fund is worth making it stand out. The jury is still out there. Still – if you like this part of the energy sector and prefer a more hands-on approach, this is a fund worth considering.
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