For attracting institutional money in investment management, a major advantage is being able to demonstrate a performance history during three- and five-year periods. A compelling track record through shorter periods can work, too, but many institutional investors view three- and five-year returns as key hurdles for allocating funds.

And if you have a 10-year track record, all the better. Portfolio Manager Todd Williams, certified financial analyst (CFA), and his team at Dallas-based Westwood Holdings Group can boast that 10-year track record. Performance histories stretching back a decade or more are not around every corner in the investment management business, and perhaps even less so in the realm of master limited partnerships (MLPs), a sector that has flourished particularly strongly in recent years.

The track record is more than respectable for Westwood MLP Infrastructure Renewal (inception: January 1, 2003).

During a 10-year trailing period, it has outperformed its benchmark Alerian MLP Index by 370 basis points (330 basis points net of fees), earning returns of 19.7% per annum (19.3% after fees), as compared to the 16% per year chalked up by the Alerian MLP Index during the same period. Williams says Westwood’s MLP assets under management total nearly $600 million. For separately managed accounts, there is a $5-million minimum. There is no public MLP investment vehicle, although there is a qualifiedplan vehicle available through Westwood’s trust services. Total assets under management at Westwood are close to $16 billion.

So what’s the secret sauce in the blend of investment process and style used by the Westwood MLP team to put together its track record?

Team leader Williams gives due credit to his MLP team, which includes Mark Easterbrook, CFA, director of research; and Matthew Na, CFA, research analyst. In addition, he notes that Westwood—as a larger firm managing assets across all market capitalization segments—has 16 research analysts and can extend its research coverage to all publicly traded oil and gas producers as well as undertake research on the broader economy and on certain sectors important to MLPs.

Holistic investing

All this helps Westwood to take what Williams calls a “holistic” approach to managing its MLP portfolio.

“We take what we call a holistic approach to the asset class, meaning that we don’t believe MLPs operate in a vacuum; time spent analyzing the supply and demand trends affecting energy infrastructure is really the leading edge to successful MLP stock selection,” Williams tells Midstream Business.

“We follow closely what’s happening on the supply side, because that’s a key driver of where the infrastructure is headed. And on the demand side, we follow what the utilities, refineries, industrials and the petrochemical sector are doing, and what that means for MLPs, because the MLP sector is really the logistics provider between the two,” he says.

Williams describes Westwood as having a “value-oriented” investment style and using a bottom-up process toward stock selection. Analysts are charged with coming up with recommendations, which are presented to a formal research group and vetted by it as a peer-review body. If an idea is approved, it is then passed on to the portfolio team for possible inclusion. Historically, the portfolio has been made up of between 25 and 35 securities. Weightings may vary; the average position size is around 3%.

In addition to typical spreading of risk over a number of portfolio holdings, Westwood pays particular attention to levels of aggregate risk in its portfolio using various measures, including geographic risk, commodity-price risk, exposure to certain asset types and liquidity requirements, among others. Risk management is also enhanced by devoting considerable focus on actively trying to quantify the downside risk of names held in the portfolio.

“A differentiating factor for us is we focus on the downside risk in our analytical work at the analyst level,” says Williams. “We spend a lot of time trying to quantify that, because a hallmark of our firm is protecting the downside. We really want to make sure that it is tolerable and also quantifiable. That’s an important step in our research process.”

MLP categories

In terms of sub-segments of MLPs, Westwood divides its holdings into a half a dozen categories. The largest is a natural gas/diversified group, made up, in large part, of MLPs with long-haul assets, including Enterprise Product Partners LP, Kinder Morgan Energy Partners LP and others. This group recently comprised about 41% of portfolio holdings. Crude and refined products was the next largest, with 23% of holdings, followed by midstream gathering and processing, with 19%. Upstream MLPs accounted for 9% of holdings and coal made up 3%.

So what individual MLP names does the Westwood team favor in a late third-quarter interview? Summit Midstream Partners LP is a name that Westwood acquired on the company’s initial public offering (IPO), at the time yielding 8% and reflecting the market’s expectation of relatively little-growth prospects. The Westwood team met with Summit Chief Executive Stephen Newby and came away convinced that the market was underestimating its growth prospects.

In addition, it offered an under-levered balance sheet, limited downside, strong distribution coverage and an attractive valuation.

“That’s the combination we really look for,” says Williams, noting Summit has raised its EBITDA guidance twice already in 2013, up 26% from the original guidance level.

Williams checks off a variety of other achievements. Summit has benefited from a dropdown of assets from its general partner, has made a significant acquisition, and it has announced further growth projects at the limited-partner and general-partner level. The market has now recognized its growth, trading it up to yield just 5%. “And we still like it from a longer-term standpoint,” he says. “Even though it’s been revalued, we still think there is upside opportunity.”

Another Westwood-favored stock is NGL Energy Partners LP, a name that’s been “flying under the radar screen and has really transformed itself in the past 18 months,” he says. Since its IPO in 2011, NGL has grown new parts of its business—its water and crude logistics businesses—to the point that its original propane operations constitute only about 20% of EBITDA, down from as much as two-thirds earlier. In the current fiscal year ending March 31, 2014, EBITDA is projected to reach $225-260 million, up from $170 million last year and $36 million a year earlier.

“We’re talking about 600% EBITDA growth over the last two years,” observes Williams, who estimates distributions by NGL will grow by close to 15% this year.

“I don’t know of another MLP that has grown that fast. It’s really the only MLP out there with a significant water-handling and treatment business. They recently did an acquisition in the Eagle Ford on the water side, and that has really given them significant scale when you combine that with their existing assets down there,” he says.

Corporate investments

Although an MLP manager, Williams’ mandate is such that he can also invest in infrastructure and upstream plays through C-corporation positions. These account for about 9% of assets, split among Consol Energy Inc., EQT Corp., Kinder Morgan Inc., Occidental Petroleum Corp. and Williams Companies Inc.

He highlights Consol Energy, a company with assets in both coal and natural gas, as well as other assets whose value is less recognized by the market.

“Of all our holdings, I think this one has the largest disconnect between its public market valuation and its intrinsic value,” says Williams. “They have great assets on both the coal and gas side. They’re a low-cost producer on both of those commodities. Even in today’s low-cost environment for coal and gas, they’re generating positive cash flow. In terms of a possible restructuring, we think the sky is the limit for them, either breaking up the company, selling assets to other MLPs, or forming their own MLP. There is just a lot of avenues they can pursue to unlock value.”

Meantime, Williams says Consol will harness its “vast natural gas base” in the Marcellus and the Utica basins— acreage that is predominately held by production—where output is expected to grow by about 10% this year and about 25% next year.

As for often overlooked assets, he points beyond Consol’s joint venture in the Marcellus with Noble Energy to a further 60,000 acres in the Marcellus that it owns by itself. On the coal side, Consol also owns a port in Baltimore and a dockservices business with a fleet of more than 600 barges.

Although Westwood selects stocks using a bottom-up approach, the team still has to handle headwinds in the form of rising interest rates. In an environment in which the yield on the 10-year U.S. Treasurys has recently risen from around 1.65%, to briefly touch 3 %, what tools are available?

“I think what you can do as a portfolio manager is pay attention to the valuations in your portfolio, and that should drive your decision-making,” says Williams. During the recent backup in interest rates, MLPs outperformed other asset classes that are yield-oriented by a substantial margin, he observed, noting this in part was reflected by the expected growth in MLP distribution. He estimated the pace of distribution growth for the Alerian MLP index at 7%-8%. The Westwood portfolio-distribution growth is expected to be closer to 10%, he added.

“If rates are going to continue to rise, there naturally is going to be an adjustment period that MLPs will have to go through,” he cautions. “But that growth component is pretty significant if you can grow your distributions 7%-8%.”

As Williams peers into his crystal ball, how far out can he see the infrastructure build-out lasting and the opportunities in the MLP sector continuing?

“We’re clearly at a unique and exciting time in the world of energy. I’m not sure of another time when so much is changing in energy-production growth, in drilling and completion efficiencies and in growing infrastructure needs,” he says. “According to our numbers, the backlog of midstream-infrastructure projects stands at between $120- and $130 billion over the next four years, so we may be past the midpoint of the current infrastructure wave.”

Williams acknowledges being surprised by as much as $30 billion of infrastructure projects announced by Spectra Energy, Williams Companies, TransCanada and others in the second quarter.

“We think we are starting to enter a transition period away from ‘supply-push’ projects and toward ‘demand-pull’ projects. Unless there is a step-function increase in future supply out of these growth basins, then we’ve largely solved a lot of the debottlenecking and infrastructure needs to move energy out of these areas to where it needs to go. We may start seeing more ‘base-hit’ projects on the demand side of things going forward, which would mean, in theory, that backlog growth would be slowing,” he says.

In any event, Williams expects to see a continuing bifurcation between what he calls the “haves”—MLPs operating in growing supply basins that have connection to the right markets—and the “have nots,” that lack the same elements for success.

“It’s obviously becoming increasingly expensive to go from a ‘have not’ to a ‘have.’ We believe we’re at a critical point where active MLP management is going to be crucial going forward.”

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