Covestor model: MLP Total Return
On Thursday, October 27th, I liquidated approximately half of the MLP positions in my Covestor portfolio, and I wanted to give a bit of color as to why I did so.
In the course of my research on MLPs, I have found one metric in particular that, historically speaking at least, has had the ability to predict with a high degree of accuracy the total return of MLPs as an asset class over the following two years.
A high reading on the metric today would indicate to me that it is likely that MLPs as an asset class will likely deliver low total returns over the following two years, whereas a low reading on the metric would indicate that MLPs will likely deliver high total returns over the following two years. Because I select MLPs for my Covestor portfolio based on a one-to-two year time horizon, I believe that this metric is extremely valuable and worthy of careful attention.
I call the metric described above the Future Returns Metric, and it is proprietary to my firm, BGG MLP Research. As per my model page ‘Research’ section, the inputs to our research are financial statements and annual reports, plus open market purchases and sales from directors and executive officers at publicly traded MLPs.
The Future Returns Metric is indexed at 100. To give you an idea of how to read the Future Returns Metric and what it means, I offer the following (all of which is based on historical data):
● A reading of 100 would mean that MLPs are valued in line with historical norms and are poised to deliver significant positive total returns over the following two years.
● A reading of 80 would mean that MLPs are significantly undervalued and are likely to deliver extraordinarily positive total returns over the next two years.
● A reading of 120 would mean that MLPs are somewhat overvalued and are likely to deliver either flat or negative total returns over the next two years.
I calculated the Future Returns Metric on October 27th, and it stood at approximately 116. Based on historical returns, this indicates that MLPs as an asset class will likely deliver a small positive total return over the next two years.
After seeing that my Future Returns Metric and a couple of other proprietary metrics (which I will discuss in future investor updates) each indicated limited upside at today’s price levels, I decided to liquidate about half of the MLP positions in my Covestor portfolio in the hope that I will be able to re-enter the market when MLPs present a more attractive tradeoff between risk and reward.
However, because the Future Returns Metric, like all financial metrics, is imprecise and has a non-trivial standard error, about half of my Covestor portfolio remains invested in MLPs.