Active and Passive Strategies in Energy Infrastructure

For investors that want the option of picking stocks but do not feel comfortable doing it themselves, active management is an option, but there are several things to watch for. Typically, investors want to consider the performance of the sector overall to determine if and how they want to invest in it, but that can be a bit more problematic in energy infrastructure, as it is still a somewhat newer sector, according to Alerian.

The market cap of EI has been increasing exponentially since the mid-2000s, and it is that growth that drew active managers to the midstream space. With competition continuing to grow, it is important for investors to look at the performance history of the money manager as well when considering overall sector investment.

Active funds carry higher fees, and so it is important to find an active manager that can not only outperform their benchmark, but can outperform it enough to provide returns after fees. When considering the performance history of a manager, one year of outperformance may look impressive, but it is better to find an active manager that has outperformed over multiple years and under a variety of market conditions. If the manager or fund has underperformed the benchmark, investing in a passive strategy could be a better alternative.

A final caution when considering active managers is to be familiar with what is in the underlying portfolio and ensure that it doesn’t just mimic the benchmark; doing so is called closet indexing, and the money that is allocated to costly active management fees could be saved by investing in less expensive passive strategies. Investors should ensure that the securities within the underlying portfolio align with the investment strategy of the fund as well as the fund manager’s philosophy.

Alerian was the first to launch a real-time MLP index in 2006, one that has gone on to become the benchmark for the energy infrastructure industry. As such, they have helpful guidance when considering a passive strategy and the underlying indexes they pull from. Indexes featuring EI are varied, with some focusing on midstream investment and others being more income-driven, while others are comprised entirely of MLPs.

One of the most important benefits of passive strategies is a transparent underlying index; if that transparency isn’t there, the strategy is more aligned with active management than passive. Investors into passive strategies should have access to the details on what the underlying index holds, and any changes that are made should be publicly available. This enables the investor to ensure that the securities contained within the portfolio align with the investment strategy.

Indexes should be constructed objectively and should contain readily available rules that keep potential individual prejudices or perspectives from interfering with constructing the index and the securities it follows. Investors should look for publicly available, codified rules regarding index construction and rebalancing, and rules that prevent index committee members from holding positions in EI companies within their personal accounts. This keeps the index objective and prevents bias.

For more news, information, and strategy, visit the Energy Infrastructure Channel.