EIP starts with the answer: total return is comprised of yield, growth, and change in valuation. We work backwards from there.
Investment Philosophy
“EIP’s conservative approach to investing in quality companies is informed by its unmatched energy investing experience. EIP’s portfolio construction takes a wide stance so it can better absorb punches from an uncertain market while exploiting opportunity.”
Our approach is consistent across all our investments.
Earnings stability is the primary attribute we look for because we believe it leads to superior growth and higher dividend pay-out ratios.
We then focus heavily on the quality and track record of the management teams.
Perspective is gained from engagement with all key stakeholders in the energy space, including management teams, regulators and policy makers, as well as working knowledge of industry history.
Our strategy is consistent over time. Only the opportunities in the market change.
Total Commitment to Total Returns
Total return for equities is, very simply, the sum of the dividend yield plus or minus changes in the share price.
Short-term price movements can be volatile, driven by changes in market sentiment. But over the longer term they follow trends in per share earnings and dividends.
Separating these price changes into their two component parts – growth and valuation change – leaves us with this simple equation:
This simple equation is the framework that underpins our stock selection and portfolio construction.
While alpha and beta are often used to describe results, they are only useful after the fact and provide no insight into the components and risks of expected future returns.
Our focus on total return is our North Star when intra-portfolio volatility provides opportunities to dynamically adjust position weightings.
Why Energy Infrastructure
Working backwards, in the world of energy, we believe the best returns come from energy infrastructure companies with the following attributes:
STABLE AND GROWING EARNINGS for infrastructure companies derive from stable margins on growing capital, not variable margins on sales. Earnings stability is positively correlated with long term growth and dividend payout ratios.
GROWTH in energy infrastructure is driven by growth in the asset base upon which returns are linked: connecting new supplies, increasing efficiency, safety, reliability and reducing environmental impact drives network investment.
YIELDS are driven by dividend payout ratio and share price. Stable cash flows allow for higher payout ratios.
VALUATION matters, but no more than yield and growth, the other two drivers of total return. Valuation is based on a broad analysis of equity prices across all sectors.
Energy infrastructure assets such as pipelines, transmission lines, terminals and storage facilities are unlike other energy assets.
These natural and legal monopolies operate under a cost-plus regulatory construct or long-term contracts that mimic such regulation, earning an allowed or agreed return on their invested capital. Since this capital base is stable and growing, earnings tend to be stable and growing.
This differs dramatically from the rest of the energy industry which is cyclical by nature. This cyclicality distracts management and shareholders, disrupting business planning and hurting long-term returns.
Successful Investing in the Energy Transition
The transition in the energy industry is characterized by the same dynamic that all industries experience: supply and demand migrate towards products that are lower cost and perform better. For energy, a critical part of performance is environmental impact but so too are safety, reliability, resilience, convenience and even national security.
For investors in mature commodity industries like energy, what matters is per-share profitability, which can often accrue to the parts of the industry with the least top line unit growth if management is frugal with capital and operating expense. Energy investors in areas with high unit growth – whether conventional or alternative – have long been plagued by poor per share profitability due to industry over investment, margin pressure and financial dilution.
Risk and Volatility
Volatility is not the same thing as risk – a distinction that is widely missed. EIP distinguishes between share price volatility and underlying business risk.Protection Against Business Risks:
Safe Balance Sheet | Sustainable Dividend | Management Team Quality
Companies with these attributes tend to have less price volatility.
While changes in market sentiment invariably drive share prices, EIP views these price swings as an opportunity to rebalance the portfolio. This tends to lead to higher returns than would be seen in a more static portfolio.
Our returns are driven first and foremost by identifying high-quality companies with stable and growing earnings. Our skillset and multi-generational perspective make us investors, not traders. However, medium-term profit opportunities are not ignored.
Risk is managed by concentrating on the resiliency of earnings and dividends, which tends, in our opinion, to reduce (but not eliminate) share price volatility.
*There is no guarantee that EIP’s investment approach will be successful.
Investment Process
Portfolio construction and security selection are equally important in EIP’s investment process.
Identify
- Stable earnings
- High payout ratios
- Potential restructuring candidates
Cull
- leverage
- earnings growth
- management skill
- regulatory environment
Build
Reduce portfolio risk by:
- maximizingexposure to stable monopoly businesses
- minimizingexposure to cyclical commodity exposed businesses
- diversifyingby business segment, geography and market cap
Portfolio construction is just as important as security selection. Quality and expected IRR drive stock selection while portfolio diversification and risk determine position size.
Total return, not relative return, is the objective, because we are investing our own capital. We don’t “invest alongside our clients.” They invest alongside us.
Our business strategy is geared towards portfolio returns, not asset gathering, so our portfolios do not align with many investors’ asset allocation categories.
We are agnostic on corporate structure, index membership or industry sub-sector, but devout believers in the attributes that drive performance.
The Result: EIP’s longest running portfolio has beat the S&P 500 and Energy Sectors since inception in 2003*
*The energy sectors referred to above are: S&P 500 Energy Index (SPNTRENRS), and PHLX Utility Sector Index (UTY). An investment cannot be made directly in an index. Past performance is no indication of future performance.
“The business of running an asset management firm should complement rather than detract from the business of running a portfolio.”
CEO, Energy Income Partners