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Monday August 30, 2010
Income expert eyes Cushing MLP Total (SRV)
by Carla Pasternak, editor High-Yield Investing  The Cushing MLP Total Return Fund (SRV) is a closed-end fund that invests in master limited partnerships (MLPs), MLP bonds, and natural resource companies that are not publicly traded.In addition to providing diversification, SRV provides a huge advantage over investing in individual MLPs. Unlike individual MLPs, SRV is classified as a corporation for tax purposes and doesn't generate a K-1 form or unrelated business taxable income, which can be taxable in an IRA. In short, SRV offers the high income of MLPs without the tax hassle. The fund pays quarterly distributions of $0.225 per share which translates to a stunning 10.3% yield ($0.90/$8.70). The quarterly distribution was reduced from $0.33 in the last quarter of 2008 as many MLPs in the fund's portfolio cut distributions and their unit prices plummeted. The falling prices forced the leverage ratios beyond allowable numbers and SRV was forced to sell portfolio positions at low prices during the crisis. 
Distributions over the past twelve months were classified as 100% return of capital. However, this is not the same type of ROC paid out by funds with a managed distribution policy that need to supplement their distribution by drawing on their equity base. In contrast, the fund's distribution reflects the return of capital, which is essentially cash flow, that most MLPs pay out. The income is not taxable until the fund is sold, when it is charged against the cost basis. The difference between the purchase price and the reduced cost base is taxed as ordinary income. On June 30th, top MLP sector holdings included natural gas processors, general partners (which tend to have lower yields but higher distribution growth rates than regular MLPs), and MLP bonds. The largest individual holdings were midstream natural gas company MarkWest Energy Partners, propane supplier Inergy Partners, and 9% bonds due April 15, 2019 of natural gas storage and transportation company Energy Transfer Partners. SRV also used leverage for 28% of the portfolio. The fund's use of leverage helps boost the distributions and enables it to yield 10%. According to fund manager Dan Spears, the underlying portfolio (without leverage) currently yields about 7.5%. The fund's borrowing costs are currently less than 1% and low borrowing costs enable the fund to also buy bonds and take advantage of the large yield spread. The fund is currently selling at a steep +12% premium to its net asset value. That compares to a +28% average premium over the past year. New management took over this fund in January of 2009. For 2009, SRV returned +123% and ranked in the top 1% of Morningstar's natural resource category. As well, year to date NAV returns of +30% have solidly outperformed the S&P 500 as well as the fund's peers. Action to Take --> Management appears to be aggressively ratcheting up net asset values through the use of leverage and secondary offerings. As such, I consider SRV appropriate for more risk-tolerant investors willing to take on the inevitable volatility that comes with these strategies in return for a double-digit yield supported by a solid MLP asset class. Learn more about this financial newsletter at Carla Pasternak's High-Yield Investing. |
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