Investment Solutions

Quarterly Report – June 30, 2014

July 16, 2014

As noted in our first quarter report, the Fund’s performance especially benefitted from our long standing “Energy Value Chain” approach as well as timely asset allocation moves both on the long and short sides. We believe the investment outlook for energy stocks continues to be very positive on a macro basis, namely oil prices averaging $99.97 per barrel over the first half of 2014, which contrasts with bearish forecasts by many analysts made last year. While production in North America has increased significantly, supply concerns emanating from the Middle East and OPEC specifically, were underestimated, and demand has risen. Natural gas production, up 5% since year-end 2013, averaged $4.85 over the first two quarters of 2014. While higher commodity prices are initially bullish for equities, we point out that lower natural gas costs have had a dramatic bullish impact on user demand over the long-term.

In our 2013 mid-year Fund report, we noted that the strong oil price was a very positive fundamental factor for almost all of the energy subsectors and we expect this will continue. Natural gas production, more so than oil, because of the shale impact, has increased dramatically: up 10% since the lows of 2012.

In our opinion, the “Energy Renaissance”, is growing as a major investment theme. Infrastructure expansion is booming as oil and gas and related production has to be transported from supply sources to markets. A vital component of the shale induced production explosion of oil and gas is energy independence, which is critical for the U.S. economy and national security. Events in Ukraine and the Middle East are contributing momentum to the necessity of increasing energy expenditures. The Interstate Natural Gas Association of America (INGAA), which represents the country’s pipeline industry, estimates $640 billion will have to be spent on oil and gas infrastructure between 2014 and 2035, while the American Chemistry Council lists 110 new projects in the U.S. totaling about $77 billion. This directly benefits the MLPs and we believe future projections of energy growth will exceed present forecasts.

Although the very positive macro outlook is critical, continued focus on sector asset allocation and individual company stock picking is essential. As value investors, we attempt to buy into themes early and are willing to wait, if necessary, if convinced our position is correct. This approach also applies to companies that are out of favor. Examples are Cabot Corporation, Linn Energy LLC, Calumet Specialty Products, and Crestwood Energy Partners, which are currently in the portfolio.

In conclusion, we remain very positive on the outlook for the energy space. Fundamentals for energy infrastructure are improving. Natural gas and oil projects need to be accelerated to keep up with expanding production. Low cost U.S. shale drilling is the important game changer that is revitalizing many important industries. Political pressures are mounting on the Obama Administration and Congress to accelerate liquefied natural gas (LNG) and oil exports. We believe these, and other major developments such as upgrading of the electric transmission power grid and energy independence are also important themes. As noted in prior reports, we believe the energy sector should outperform the stock market over the long term. We continue to maintain our thematic approach largely around shale in selecting stocks that offer above average total returns, namely a combination of dividend growth and capital appreciation.

As noted in prior reports, we believe that the energy sector should outperform over the longer term. Expanded drilling and lower costs are positively impacting many areas of the ecomony, and we therefore continue to benefit from the Fund’s “energy chain” approach to investing in the space. It provides the necessary flexibility to navigate the changes that are occurring in such industries as chemicals, railroads, engineering, and shipping to mention just a few. In fact, we approximate that the Fund’s portfolio holdings currently encompasses at least 50% of the S&P 500 Index.

In summary, while it is encouraging to have posted a strong first half performance, we are mindful of portfolio volatility and continue to be active in hedging and taking profits.

Paul Elliot, CFADan Tulis, CFAJames Elliot, CFA
212-603-7585212-603-7581212-603-7580

Certain statements contained herein may contain "forward-looking statements" within the meaning of the Private Securities and Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of the Fund to be materially different from any future results, performance or achievements expressed or implied by such forward- looking statements. Such factors include, among others, risks and uncertainties associated with the timing and costs of energy sector production, the demand for and prices of oil/gas products, the timing and amount of capital spending in the nation and world wide, and general economic factors. This report is not a recommendation to either buy or sell any securities mentioned.

 

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About ELCO Management, LLC
Established in 1995 and based in New York, ELCO Management (www.elcomanagement.com) offers investment solutions to high net worth individuals and institutions. ELCO also manages two highly specialized energy funds: the ELCO Energy Fund, L.P. and the ELCO Select Fund L.P.