CTR: A Good Fund With An Upcoming Merger Opportunity (NYSE:CTR)

The ClearBridge MLP and Midstream Total Return Fund (NYSE:CTR) is one of a handful of remaining closed-end funds that focus on investing in midstream energy companies and partnerships. The reason why I state that there are only a few remaining funds in this category is that some of them converted into exchange-traded funds (such as all four of the ones that First Trust used to offer), were merged into other funds, or were discontinued due to limited investor interest. Many of these funds suffered severe losses in either 2015 or 2020 that were amplified by their leverage, and these disappointing performance histories could scare off some investors. In addition, energy companies in general have underperformed the market over the past decade, and that underperformance has prompted investors to move their money into other sectors of the market that have provided stronger returns. Finally, many of these funds traded at very large discounts relative to the value of their assets, so the thinking is that the fund could have better share price performance if it is structured as an exchange-traded fund instead.

In a previous article, I explained some reasons why midstream companies and master limited partnerships deserve a place in your portfolio:

Master limited partnerships have a number of characteristics that are quite attractive for individuals who are in need of income. In particular, most master limited partnerships enjoy remarkably stable cash flows and pay out fairly high yields.

The ClearBridge MLP and Midstream Total Return Fund allows investors to include master limited partnerships in a retirement account, which is something that would ordinarily carry fairly significant tax consequences. This fund handles all tax issues on a fund level and distributes a 1099 form to American investors, just like any other corporation. Thus, it can be much easier to deal with when tax season rolls around every year. On the downside, though, its 6.94% current yield is not nearly as high as that of many master limited partnerships. The Alerian MLP ETF (AMLP), for example, currently yields 7.36% based on its distributions over the past twelve months.

The yield of the ClearBridge MLP and Midstream Total Return Fund is also quite a bit lower than that of many of its peers:

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As we can immediately see, the yield of the ClearBridge MLP and Midstream Total Return Fund is quite a bit lower than that of many of its peers. This is something that might discourage income-focused investors from purchasing its shares. After all, it is pretty easy to get a much higher level of income by purchasing shares of most of the other funds shown in the chart. That alone does not necessarily mean that this is a bad fund, though, as the low yield relative to its peers does suggest that the market believes that this fund can sustain and possibly even increase its distribution.

As regular readers can likely remember, we previously discussed the ClearBridge MLP and Midstream Total Return Fund in late January 2024. The market for master limited partnerships has been fairly strong since that time, as the Alerian MLP ETF has been trending upward along with the S&P 500 Index (SP500):

As such, we might expect that the shares of the ClearBridge MLP and Midstream Total Return Fund have also been doing pretty well. That is indeed the case, as shares of the fund are up an impressive 8.19% since that previous article was published. This is sufficient to beat the Alerian MLP ETF, although this fund’s shares still underperformed the S&P 500 Index overall:

Thus, investors in the fund will probably be reasonably pleased with its performance over the past five months. After all, beating the Alerian MLP ETF was a pretty impressive feat, and we can see that this fund was even outperforming the S&P 500 Index until the middle of June.

It is important to note though that investors in this fund did even better than the above chart indicates. As I stated in various previous articles:

Closed-end funds typically pay out most or all of their investment profits to their investors in the form of distributions. The basic objective is to keep the portfolio relatively stable in size while giving the investors all of the profits. This differs somewhat from an exchange-traded fund that rarely has any realized capital gains and depends primarily on share price appreciation to reward its investors. The fact that these funds pay out all of their investment profits is the reason why they tend to have higher yields than just about anything else in the market. It also results in shareholders doing much better than the price performance alone would suggest. Therefore, we need to include the distributions that the fund pays out in any discussion of its performance.

When we include the distributions that were paid out by the ClearBridge MLP and Midstream Total Return Fund over the five-month period, we get this alternative to the performance chart above:

This seems even more likely to please potential investors who are interested in either income or total return. As we can immediately see, the fund ended up outperforming both the Alerian MLP ETF and the S&P 500 Index with an 11.99% total return over the five-month period. That is a 31.23% annualized return, which is very solid for any asset.

Unfortunately, it seems somewhat unlikely that the fund will be able to continue to deliver gains at a similar rate over the remainder of this year due to numerous signs that the market strength may be starting to stall. In particular, I am referring to signs that the economy is weakening to the point where a recession may be inevitable. For example, consider the following:

• The revised first-quarter 2024 GDP report shows that the personal consumption component came in at +1.5%, which was the lowest figure recorded since the second quarter of 2022.
• According to Deloitte’s 2024 summer travel survey, 42% of Americans do not plan to travel this summer due to financial inability. This is an increase over the 37% who said the same thing last year.

The second of these factors could have an impact on domestic gasoline demand, which could put some short-term pressure on oil prices as well as the assets held by this fund. The weakening of consumer spending could put pressure on every market segment, though, especially when we consider how important consumer spending is to American economic output. If we look out more than a year or two though, we see that the fundamentals for midstream energy companies are much stronger than many in the media seem to think, so there could be some potential for those who are willing to be a bit patient. We will be sure to discuss that further later in this article.

About The Fund

According to the fund’s website, the ClearBridge MLP and Midstream Total Return Fund has the primary objective of providing its investors with a very high level of total return. However, the fund’s website does not explicitly state how it will achieve its objectives. In fact, the only information that it provides about its strategy is that it invests in midstream corporations and partnerships:

We immediately see that the fund does not state whether it invests in common equities, preferred equities, debt securities, or some combination of these. As many midstream companies issue both common equity and debt securities (and some also issue preferred stock), this is important as we want to know exactly what we are purchasing. With that said, though, the assumption with a fund targeting total return is that it will invest in either common equity or a combination of equity and debt, but it would be nice if the fund explicitly stated that.

The annual report provides a much better strategy description:

The Fund’s investment objective is to provide a high level of total return, consisting of cash distributions and capital appreciation. The Fund seeks to achieve its objective by investing primarily in energy master limited partnerships (“MLPs”) and energy midstream entities. Under normal market conditions, the Fund invests at least 80% of its managed assets in energy MLPs and energy midstream entities.

For purposes of the 80% policy, the Fund considers investments in MLPs to include investments that offer economic exposure to public and private MLPs in the form of MLP equity securities, securities of entities holding primarily general partner or managing member interests in MLPs, securities that are derivatives of interests in MLPs, exchange-traded funds that primarily hold MLP interests and debt securities of MLPs. For purposes of the 80% policy, the Fund considers investments in midstream entities as direct or indirect investments in those entities that provide midstream services including the gathering, transporting, processing, fractionation, storing, refining, and distribution of oil, natural gas liquids, natural gas and refined petroleum products. Energy entities are engaged in the business of exploring, developing, producing, gathering, fractionating, transporting, processing, storing, refining, distributing, mining or marketing natural gas, natural gas liquids, crude oil, refined petroleum products or coal. The Fund may also invest up to 20% of its managed assets in other securities that are not MLPs or midstream entities.

This description explicitly states that the fund’s portfolio might include common equity or debt securities issued by midstream corporations and partnerships. However, most of the security types that it lists are either common equity or derivatives of common equity. Thus, we can probably expect that most of the fund’s holdings will consist of common equity at any given time. This is important because debt and equity securities have very different return profiles. In particular, debt securities almost always move in the opposite direction of interest rates. However, that is not true for equity securities as historically the S&P 500 Index has exhibited a positive correlation to the federal funds rate:

As we can see, over most of the past thirty years, equities have actually gone up when interest rates rise and vice versa. It is only very recently that equities have required falling interest rates to deliver positive returns. The reason for this historical correlation is that typically the Federal Reserve raises interest rates to cool an overheating economy and vice versa. As interest rates are typically only cut to combat recessions, stocks have already turned lower due to reductions in corporate profits. Despite the events of 2022, we can see that this historical correlation has not really been broken except in very short-term periods. In addition, master limited partnerships and midstream companies actually delivered gains to investors in 2022 despite many other things in the equity market declining. Thus, if the ClearBridge MLP and Midstream Total Return Fund is investing mostly or exclusively in equity securities issued by midstream companies and partnerships then we can expect that its interest-rate risk will be much lower than if the fund is heavily invested in debt securities issued by the same companies.

The fund’s first quarter 2024 holdings report states that the fund held the following asset allocation on February 29, 2024:

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All of the master limited partnership holdings consist of common equity units as opposed to preferred or debt securities:

Thus, as of February 29, 2024, the only debt securities that were held by the fund are the ones owned by the money market fund that is storing the fund’s cash position. That fund is the JPMorgan 100% U.S. Treasury Securities Money Market Fund – Institutional Class (JTSXX). That fund appears to only hold U.S. Treasury bills, bonds, and notes. Some Treasury-only money market funds also include repurchase arrangements that are backed by U.S. Treasury securities, but the website of this particular money market fund makes no mention of those being a permissible holding. Thus, it appears that the only debt securities held by this fund are a very small handful of U.S. Treasuries. Overall, it should very much trade in line with the general performance of midstream companies, as opposed to in line with interest rates.

As we can clearly see above, the largest single asset class held by the ClearBridge MLP and Midstream Fund is master limited partnerships. However, not all of the largest positions in the fund are master limited partnerships. The fund’s website states that its largest positions as of May 31, 2024, were:

Targa Resources (TRGP), ONEOK (OKE), The Williams Companies (WMB), and Antero Midstream (AM) are all corporations. The only master limited partnerships on the list are Energy Transfer (ET), Enterprise Products Partners (EPD), Western Midstream Partners (WES), MPLX (MPLX), and Plains All American Pipeline (PAA). It is perhaps surprising to see that nearly half of the companies on the top ten holdings list are corporations when master limited partnerships account for a substantially larger percentage of the fund’s overall holdings, but that is exactly what we see here.

One big reason why the four corporations can account for four of the fund’s largest ten positions is because there are not very many of them in the fund’s portfolio. The first-quarter 2024 holdings report only lists nine corporations:

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There are far fewer corporations held by the fund than master limited partnerships. However, the fund’s corporate holdings are highly concentrated in just a few names, and these concentrations are sufficient to result in these positions being larger as a percentage of the overall portfolio.

One thing that we immediately notice is that the first-quarter 2024 holdings report states that the fund’s holdings of Enbridge common stock are larger than its holdings of Antero Midstream. However, Enbridge is not listed among the fund’s largest holdings on May 31, 2024. This suggests that the fund might have sold off its Enbridge position sometime between the start of March and the end of May. We see that the fund’s money market holdings increased substantially over that period, so it must have sold something to fund the increase that took place. Enbridge is not listed among the fund’s top 23 holdings (which is all that the website provides as of May 31, 2024) so this seems to be the most logical source of cash to fund the substantial increase in the money market fund position.

Reasons For The Money Market Position Increase

At this point, it seems likely that some readers will wonder why the fund would increase its money market position to the extent that the fund clearly did over the March 2024 to May 2024 period. After all, it makes no sense to hold money market assets yielding 5.14% (the current yield of the money market fund used by the ClearBridge MLP and Midstream Fund) when it can earn a substantially higher return by investing in master limited partnerships or even midstream corporations that have higher yields and capital gains potential.

The answer to this can be found in a press release that the fund issued last week:

ClearBridge MLP and Midstream Total Return Fund announced today the expiration and preliminary results for its issuer tender offer for up to 50% of the outstanding shares of common stock of the Fund. The Tender Offer expired on Thursday, June 20, 2024 at 5:00 p.m., New York City time.

Based on current information, approximately 3,774,769 Shares were duly tendered and not withdrawn. Because the number of Shares tendered exceeds 3,443,416 Shares, the Tender Offer has been oversubscribed. Therefore, in accordance with the terms and conditions specified in the Offer to Purchase, the Fund will purchase Shares from all tendering stockholders on a pro rata basis, disregarding fractions. The purchase price and final number of Shares validly tendered and accepted pursuant to the Tender Offer will be announced at a later date. The Fund expects to make cash payments for tendered and accepted Shares at a purchase price equal to 100% of the per Share net asset value as of the close of the regular trading session of the New York Stock Exchange on June 20, 2024.

The build-up of the fund’s cash position was meant to satisfy its potential requirements under the tender offer. The fund’s management thought that it would be more prudent to sell off shares gradually over the past few months to build up a cash position to distribute to its investors. That makes a great deal of sense since otherwise, the fund might have been dumping shares with enough volume to affect the price of the companies in the portfolio negatively. It also allowed the fund to capitalize on any short-term capital gains that might have become available at a given time.

We can expect that the money market position will decrease to much closer to its normal historical size once the fund repurchases the shares that it promised to buy from the investors who accepted the tender offer. We can expect that to happen within two or three business days (in either direction) of when this article goes live.

Upcoming Merger With Another ClearBridge Fund

On May 20, 2024, the ClearBridge MLP and Midstream Total Return Fund announced a merger with the ClearBridge Energy Midstream Opportunity Fund (EMO). From the press release that was referenced in the previous section:

As previously announced on January 26, 2024, the Fund’s Board of Directors approved a proposal to merge (i) the Fund with and into ClearBridge Energy Midstream Opportunity Fund, and (ii) ClearBridge MLP and Midstream Fund (CEM) with and into EMO, subject to approval by stockholders of each of CEM, CTR, and EMO. On May 20, 2024, EMO, CTR, and CEM announced stockholder approval of each Merger. It is currently anticipated that each Merger will be effective before markets open on Monday, August 19, 2024, subject to all regulatory requirements and customary closing conditions being satisfied.

Investors who did not want to take part in the merger should have tendered their shares earlier in the month. After all, the fund has historically traded at a discount to net asset value, but the fund was offering to buy the shares back at net asset value.

With that said, there could still be an opportunity here for investors to make some gains from the merger. As of right now, this fund is trading at a whopping 10.36% discount to net asset value. This is quite a bit less than the 3.96% discount that the shares have averaged over the past month. If this discount were to close, it would represent some easy short-term gains for anyone buying the fund today.

The merger of closed-end funds also takes place at net asset value. Therefore, anyone who purchases the fund at a discount should be able to experience a gain once the merger closes (unless the net asset value falls significantly over the next two months). It seems unlikely that the fund’s portfolio will lose 10.36% over the next two months, given the strength of the equity market and the fact that crude oil prices have been doing fairly well this month.

Thus, this merger could present an opportunity for short-term profits. As I discussed back in April, the ClearBridge Energy Midstream Opportunity Fund is a pretty good energy infrastructure fund, so it could make sense to just hold that fund after the merger. Overall, there could be both short-term and long-term opportunities here.

Conclusion

In conclusion, the ClearBridge MLP and Midstream Total Return Fund is a very good midstream fund that might be presenting some opportunities right now. The fund’s upcoming merger in particular will almost certainly result in some gains unless the market crashes between now and the end of August. That seems like an unlikely scenario, to say the least. The fund is currently trading at a much lower price than its underlying assets, so today looks like a pretty good entry point.

Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.