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Tortoise MLP Fund Is the Latest Closed-End MLP Fund

Another month, another master limited partnership closed-end fund.

Mike Taggart, 07/29/2010

Closed-end funds welcomed their latest addition Tuesday, with the initial public offering of Tortoise MLP NTG. The fund raised net proceeds of approximately $1.01 billion, not including the underwriters' option to purchase $150 million more within 45 days. Already, it's the third-largest CEF IPO since July 2007.

The new issuance market for CEFs has been heating up in 2010, after two lackluster years. So far, we have seen 10 new CEFs, with aggregate net proceeds of $4.2 billion. However, it will be difficult to outpace the torrid IPO market of 2007, which successfully brought 41 deals to market and raised $26.5 billion in net proceeds (three of those funds have already been shuttered).

It was only one month ago that ClearBridge Energy MLP CEM launched, having raised net proceeds of $1.1 billion. That fund, initially priced at $20 per share, has so far performed well, trading at roughly $20.50. Because of underwriting fees and offering costs, the fund's initial net asset value was $19.06, but that has increased to $19.67. The shares trade at a roughly 5% premium. 

Demand for MLP funds has been high recently, as their higher, tax-efficient distributions appeal to investors who are searching high and low for sources of sufficient income. In the month since the ClearBridge MLP launch, UBS has brought forth two MLP-focused exchange-traded notes (UBS E-TRACS Alerian Natural Gas MLP Index ETN MLPG and UBS E-TRACS 2x Long Alerian MLP Infr MLPL), Cushing MLP Total Return SRV held a successful secondary offering, and MLP CEFs have been among the largest price gainers in the U.S. equity CEF group. This high demand for MLPs has caused some to fret that the underlying MLP sector is not large enough to handle such inflows of cash. Given that it can take a new fund up to six months to invest its cash, the knock-on trading effects on individual MLP shares remain to be seen. For instance, Enterprise Products Partners EPD, with a market capitalization of $23.7 billion, has seen its shares rise about 5.5% in July compared with roughly 7% for the broader equity market; and while Enterprise's yield now has come down to 6%, that is still considerably higher than the roughly 2% that the market is currently providing.

Let's take a closer look at Tortoise MLP.PAGEBREAK

Suitability
Tortoise MLP plans to invest at least 80% of the total fund assets in a portfolio of energy infrastructure MLPs, with 70% of total assets invested specifically in natural gas infrastructure MLPs. We believe this fund is suitable for investors seeking exposure to the buildout of the U.S. natural gas infrastructure and for those seeking access to the strong cash-flow generation of MLPs.

Management
Tortoise Capital Advisors is acting as the investment advisor. Tortoise has five other funds, including four CEFs and one business development company. Total assets managed in those five funds at the end of June were $3.6 billion. Tortoise MLP adds nearly a third more assets to the advisor's asset base. Tortoise also manages assets in accounts other than funds. It is one of the largest investors in U.S. energy infrastructure MLPs and, as such, is well-suited to make MLP investing decisions for you.

The portfolio will be managed by the same investment committee that oversees the other Tortoise funds. The committee is composed of David Schulte, Kevin Birzer, Zachary Hamel, Kenneth Malvey, and Terry Matlack. They are part of a 20-member investment team that looks exclusively at the energy sector. The firm is specialized, focused on the energy sector and MLPs in particular.

Leverage
The board of directors has authorized the fund to issue debt, up to a leverage ratio of 1.25 (total assets/net assets). This is the average leverage ratio for the MLP CEF group. Leverage can mean higher returns, but it also breeds volatility in both NAV and share price performance. Investors should bear this in mind.

Process
It is expected that all assets will be fully invested within three to six months. Reflecting Tortoise's expertise investing in MLPs, the managers are seeking direct placements and follow-on offerings from MLPs, wherein the MLP issues new equity at a discount to the market price. Since 2002, Tortoise has participated in about 110 direct placements worth $1.5 billion. If the fund is successful with the direct placements or follow-on purchases, investors will benefit because their collective funds will have purchased underlying MLPs at a discount.

Price
Because underwriting fees and offering costs immediately whittle away a CEF's net asset value, investors should be aware that, while the fund priced its shares at $25.00, the underlying NAV (after fees) was $23.88. The fund started life trading at a 4.7% premium.

Ongoing expenses are another matter. The fund estimates that annual expenses will run to approximately 2.36% of net assets. The management fee is expected to be 1.27% of net assets, and interest expense will add another 1.22%. Other expenses are expected to run 0.20%. The advisor has agreed to a fee waiver of 0.25% in the first year, which is typical with newly minted funds. There is also another fee waiver of 0.08%. The total expected expense ratio of 2.36% is in line with the MLP CEF group average.

Distribution Analysis
Investors have been flocking to MLP CEFs because of their high distribution rates. The irony is that, because this fund is not yet invested, there is no way to know how much it will pay out quarterly as a distribution amount, let alone what its distribution rate will be. The board of directors does expect the fund to distribute 95% of its distributable cash flow on an annual basis, although the actual distributions will be made quarterly and based on estimates of the annual amount.

Mike Taggart, CFA, is the closed-end fund strategist for Morningstar.

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