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I recently contemplated Fiduciary / Claymore MLP Opportunity Fund (FMO), which I neither own, nor am I short. Still, there appears to be a lack of awareness about FMO structural inefficiency and recent governance history. I have no interest in being long this Closed-End Fund, even as its relative valuation has become less unattractive.
FMO Structural Inefficiency
A Hazardous Mean Reversion Candidate While better known as a Closed-End Fund, FMO is technically taxable as a C-Corporation. Like other Closed-End Funds (e.g. KYE, KYN, NTG, TYG, TYY), Mutual Funds (MLPAX, MLPOX, MLPDX, MLPZX, MLPFX, MLPTX, CSHAX, CSHCX, CSHZX), and the ETF (AMLP) that invest in MLPs, its Net Asset Value (“NAV”) should account for its tax burden. I documented one demonstration of the financial effect in Nuveen’s MLP & Strategic Equity Fund Inc (MTP), upon it writing down its NAV overnight. Chuck Epstein, an award-winning financial writer who has written by-lined articles for over 50 financial publications and clearly a proponent of progressive change in the asset management industry, also just covered the C-Corporation product phenomenon among other important MLP investing topics.
In short, the C-Corporation structure generally constrains NAV performance to less than 70% of the long-term performance of underlying securities. So, assuming positive long-term returns if the asset class proves to have investment merit over time, FMO’s NAV performance is highly likely to underperform even a random sample of the MLP asset class constituent. I am not advocating the throwing of darts as there are numerous single security hazards in a sector cluttered with conflicts of interest. Significant Incentive Distribution Rights (“IDRs”) to an MLP holdings’ General Partner may be a very concerning indicator of potentially conflicted interest.
Rather, the C-Corporation structure of an MLP-focused single security investment wrapper is far less efficient than direct ownership. Therefore, in addition to inferior NAV returns, FMO may prove to be subject to insufficient market demand for its product shares, and thus be assigned a wide discount by Mr. Market over time. I’m don’t like MLP ETNs (AMJ, MLPN, MLPI), which themselves have distribution challenges and in their manufacture create new credit risk.
I love Closed-End Funds generally, but Closed-End Funds investing in MLPs may prove upon widening discounts in addition to incomplete asset class participation even worse than AMLP. To be clear, that is not a compliment to AMLP. And what appears to me worse than MLP Closed-End Funds generally, is FMO in particular. Here’s why:
FMO Governance History
FMO recently did a secondary offering, priced at $19.36, and after an $0.81 underwriting discount added $18.55 in proceeds, before expenses, to the fund. Such a governance choice for a Closed-End Fund increases Assets Under Management (“AUM”), and clearly benefits those who earn assets under management fees. The transactions are expensive to the Closed-End Fund, whose shareholders own it, and indirectly bear that expense in a Fund’s NAV performance. The additional supply of shares can have an effect on the supply/demand curve immediately. The possibility that such governance actions may reflect a Governance interest in maximizing AUM in spite of the detrimental effects may cause Mr. Market’s longer term pricing dynamics to reflect broader assessments of the fund’s governance.
Disclosure:
The above text is licensed to Covestor Ltd. (“Covestor”), by Dan Plettner. Such text may be disseminated only by Covestor. Dan Plettner invests and receives income for securities research, including “buy-side” research. Dan licenses his own real time trading data to Covestor Ltd. (“Covestor”). Covestor is a Registered Investment Advisor that uses Dan Plettner’s data to create the Core, Activism Profile Closed-End Funds, Long Short Opportunistic, Pure Short Opportunistic, Tax Advantaged Income, Taxable Income, and MLP Direct Ownership models for its clients.
