Disclosure: Author has No Position in any securities mentioned.
On Tuesday evening November 23rd 2010, Kayne Anderson Midstream/Energy Fund (KMF) announced the pricing of its Initial Public Offering (“IPO”). Closed End Fund IPOs are always priced at a premium to their Net Asset Value (“NAV”) so regardless how good or bad the investment is for its new shareholders, such an announcement always marks a particular marketing feat.
Paragraph one of the press release highlights the size of the offering:
Kayne Anderson Midstream/Energy Fund, Inc. (the “Fund”), a newly organized closed-end fund announced today the pricing of its initial public offering of common stock. The Fund agreed to sell a total of 19,000,000 shares at a price of $25.00 per share (not including 2,850,000 shares that the underwriters may purchase pursuant to a 45-day option to cover over-allotments). Shares will begin trading on November 24, 2010 on the New York Stock Exchange under the symbol “KMF” (http://www.businesswire.com/news/home/20101123006857/en/Kayne-Anderson-MidstreamEnergy-Fund-Announces-Pricing-Initial, November 23, 2010).
For those lacking mental calculatiors, 19 million shares times $25 of investor capital to acquire each would represent $475 million. Paragraph two of the press release glances at the Fund’s ojective, without discussing structural (in)efficiencies (more on that later):
The Fund’s investment objective is to provide a high level of total return with an emphasis on making quarterly cash distributions to its stockholders. The Fund seeks to achieve its investment objective by investing at least 80% of its total assets in securities of companies in the Midstream/Energy Sector, consisting of (a) Midstream Master Limited Partnerships (“MLPs”), (b) Midstream Companies, (c) Other MLPs and (d) Other Energy Companies. Net proceeds from this offering will be used to make investments consistent with the Fund’s investment objective and investment policies ((http://www.businesswire.com/news/home/20101123006857/en/Kayne-Anderson-MidstreamEnergy-Fund-Announces-Pricing-Initial, November 23, 2010).
Paragraph three and four of the press release demonstrate who got the management contracts and who what investment banks were compensated by floating the offering:
The Fund will be managed by KA Fund Advisors, LLC (“KAFA”), a subsidiary of Kayne Anderson Capital Advisors, L.P., a leading investor in MLPs. As of September 30, 2010, Kayne Anderson and its affiliates managed assets of approximately $9.9 billion, including $8.5 billion in the Midstream/Energy Sector.
UBS Investment Bank, BofA Merrill Lynch, Citi, Morgan Stanley and Wells Fargo Securities are acting as joint book-running managers. Ameriprise Financial Services, Inc., Baird, Barclays Capital, RBC Capital Markets and Stifel Nicolaus Weisel are acting as senior co-managers on the offering…(http://www.businesswire.com/news/home/20101123006857/en/Kayne-Anderson-MidstreamEnergy-Fund-Announces-Pricing-Initial, November 23, 2010).
After providing the addresses of those five investment banks, a bit of useful information to potential investors is offered:
Investors may also obtain the prospectus free of charge from the Securities and Exchange Commission’s (“SEC”) website at www.sec.gov.
An investor should read the Fund’s prospectus carefully before investing. The prospectus contains important information about the Fund and its investment objective and policies, risks, charges and expenses (http://www.businesswire.com/news/home/20101123006857/en/Kayne-Anderson-MidstreamEnergy-Fund-Announces-Pricing-Initial, November 23, 2010).
More specifically, the most recent prospectus amendment is available here within the SEC website. Good luck to the novice trying to find the same independently. Those interested in what they might be investing in would benefit to actually read it. In addition to observing customary risks associated with leveraged Closed-End Funds and the asset class, and where the up front expenses goes, it may be appropriate to contemplate the prospects of taxation as a Regulated Investment Company and/or a C-Corporation.
Apparent Structural Inefficiency
While better known as a Closed-End Fund, MLP focused funds like KMF are generally technically taxable as C-Corporation. Like other Closed-End Funds (ie: 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”) it is likely to account 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, KMF’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 conflict 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, KMF 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 surely not advocating to own 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.
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.