The idea is to avoid companies that drill and sell oil and to instead focus on service companies that help drillers move the stuff to market. That means mostly pipeline companies, said Scott Roulston, managing director at Cleveland-based MAI Capital Management, which acts as the subadvisor to Vertical's fund. The industry calls these companies "midstream players," sitting between the exploration companies at the "upstream" part of the business and the refiners and chemical companies, known as "downstream."
"We like the midstream because they're toll takers," Roulston said. "Their revenue is predictable and more visible. The industry's investment in midstream has been huge and will keep growing, even if not at the same pace.''
In other words, the midstream companies don't own oil, so they're not exposed to swings in the price of oil, Roulston said. And many details of their contracts with oil producers are publicly disclosed, making it possible for the fund to predict which MLPs will have the cash flow to increase their already-fat dividends in the future.
"There has been some disconnect in MLP fundamentals and the price declines they have experienced," said Peter Lazaroff, a financial advisor with Acropolis Investment Management who has expertise in MLPs. "Midstream MLPs have very little commodity exposure, and most of the major players haven't changed their distribution or distribution growth projections in response to the oil price decline," Lazaroff said.
He added, "Prior to the oil price declines and MLP selloff, the MLP space was looking a little frothy, so the pullback has made the asset class more attractive for new dollars." Lazaroff owns the JPMorgan Alerian MLP ETN as the best bet for broad asset allocation exposure to MLPs, and individual shares of Energy Transfer Equity, Spectra Energy Partners, and Magellan Midstream Partners.
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