Bernstein: Muni ETFs Ripe, More MLP Risk

March 03, 2015

Richard Bernstein is the chief executive officer and chief investment officer of Richard Bernstein Advisors (RBA), an investment advisory firm that uses a top-down approach to investing, focusing on macro trends rather than individual stock selection. Before founding RBA in 2009, Bernstein was the chief investment strategist at Merrill Lynch. He was voted to Institutional Investor magazine's annual "All-America Research Team" 18 times, and is one of only 50 analysts inducted into the Institutional Investor "Hall of Fame." His book "Style Investing: Unique Insight into Equity Management" is widely viewed as the seminal book on style-oriented investment strategies.

Bernstein recently sat down with to talk about overlooked risks in the MLP space due to plunging oil prices. He tells us why he's still bullish on the U.S. and the dollar, but not with emerging markets. Within fixed income, he explains why he likes high-yield muni bonds and why Treasurys continue to make sense in a diversified portfolio. The First Trust RBA American Industrial Renaissance ETF (AIRR | B-16) based off of your firm's strategy, launched only a year ago, but it's already got more than $100 million in assets. The thesis differs greatly from industrial sector ETFs, and it dips down heavily into small- and micro-caps. What are the key takeaways for this fund?
Richard Bernstein: You're right. It is a little bit different from the other industrial ETFs out there. This one is the American Industrial Renaissance, a very big theme of ours for the past three, four years. We were really early adopters of this; in fact, so early that we actually trademarked the term "American Industrial Renaissance."

The investment thesis is that U.S. small- and midcap manufacturing companies are gaining market share. We thought it was important to make sure that at least 75 percent of their sales were here in the United States. I don't think you can play the American Industrial Renaissance with a lot of the large-cap machinery or industrial companies, because they get a majority of their sales outside the United States. It's not called the "Global Industrial Renaissance"; it's called the "American Industrial Renaissance." That's why you have this focus on small- and midcaps because the majority of their sales are right here in the United States.

Now, the theme performed very well in 2011, 2012, 2013. Last year, it took it on the chin. The reason was that there was some energy exposure within the underlying index. That's going to be the case. I don't think there's a lot we can do about that. But for anyone interested in the long-term industrial play here in the United States, this is a core holding. We're still very favorable.

Admittedly in the short term here, it's going to be as volatile, as energy prices are going to be. But longer term, we think it's a great opportunity. At our recent Inside ETFs conference, you spoke about some concerns with MLPs. What dangers do you see there? What's your take on MLPs these days?
Bernstein: Our view on energy in particular is that it's been our contention that the energy sector was actually in a bubble. It's funny how people have been looking for bubbles all over the place, and the one that was actually kind of staring them in the face nobody believed was the bubble, and still doesn't believe it's a bubble. It has all the characteristics of a traditional financial bubble.

MLPs have become one of the favorite ways for people to get at income through the energy sector. What's interesting is that for the underlying MLP universe of companies, the fundamentals have changed dramatically in the last 10 years, largely because of this bubble environment. They're not even free cash flow positive anymore, which I find interesting, that people would be so interested in an income-oriented vehicle, where the underlying companies are free cash flow negative. That just makes no sense to me at all.

What that means is that they've become more and more dependent on outside financing for their cash flows. We just think that adds an element of danger that people really aren't aware of.

At the same time, everybody's convinced that MLPs are not correlated to energy prices. That's just not true. They have about a 65 or 70 percent correlation to oil prices. The fundamentals are eroding in this space. Everybody believes that oil going from $100 to $50 is going to have no impact. We find that very hard to believe. The fundamentals of these companies are no place where they were five or 10 years ago; they're much, much weaker.

Everybody says, well, won't there be good MLPs? Of course, when an industry gets in trouble, higher-quality companies outperform on a relative basis versus lower-quality companies. But the key thing in what I just said was "on a relative basis." The question is, do you even want to be in the MLP space at all?

Our contention is that it's probably much riskier than people think. There's a huge gap between the perception of what these companies are all about and the reality. What's your view on oil? We're at $45-50 for WTI now. What do you think about 2015 and beyond?
Bernstein: We don't forecast oil prices, per se. But it's a little disconcerting to us that everybody's looking for a quick bounce in the energy sector, under the suspicion that this is just a temporary retracement in energy prices. We think this is akin to the way people were talking about technology stocks in the summer of 2000, when technology stocks' prices fell quite dramatically and everybody said, "Oh, it's just temporary and you should buy them now." Well, that didn't quite work out.

That's kind of what it sounds like today, where everybody is rushing to either buy the stocks or, in many cases, buy the debt of some of these companies. We still think there's much more risk than people think.

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