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Fund Commentary

March 2018

2018 Outlook: Pipeline MLPs | Looking for an attractive alternative to traditional fixed income securities?

Looking for an attractive alternative to traditional fixed income securities? For income-focused investors, exchange traded pass-through securities have long been an area of fascination. After all, they distribute nearly all of their profits back to shareholders...

Looking for an attractive alternative to traditional fixed income securities? For income-focused investors, exchange traded pass-through securities have long been an area of fascination. After all, they distribute nearly all of their profits back to shareholders thereby creating an attractive revenue stream with the potential for strong yield generation in a variety of market environments. At LoCorr, our Spectrum Income Strategy focuses on six primary sectors: CEFs, PTPs, MLPs, BDCs, REITs and Preferred Securities. The potential combination of higher yields and low correlations to traditional fixed income has made these securities an attractive diversifier to bonds. Currently, the team is focused on mid-stream MLPs and in particular, pipeline and energy infrastructure MLPs. While we own MLPs in other sectors as well which we like for different reasons, we believe now is an excellent opportunity for the pipeline sector based on strong and improving fundamentals and very attractive valuations.

The ride for MLP investors has been volatile to say the least. The last major price move for MLPs peaked in 2014 on enthusiasm for the development of US shale and the need to transport larger volumes out of the shale basin and into major markets. Liquidity flows into the sector were bolstered by the availability of sector ETFs which facilitated participation by short-term oriented funds in addition to the traditional shareholder base of income-oriented, buy and hold investors. As we can see in the chart below, AUM in the Energy LP category, as defined by Morningstar, peaked at just under $50 bn.

*Data Source: Morningstar, Inc.; data as of 12/31/17

Excessive oil production prompted a decline in oil prices, which in turn led to a major decline in the sector as investors, particularly those short-term oriented ones, withdrew. The sector, as measured by major indexes, bottomed in the beginning of 2016, along with the price of oil. From a fundamental perspective, the pipelines themselves had been overbuilt on a short-term basis and consolidation was certainly in order, although the long-term growth potential of the US shale industry was still strong. It is worth noting that the fundamentals of the pipelines are not materially affected by the price of crude; they tend to trade with the commodity over the short-term despite the fact that their revenues and distributions are tied primarily to volume which is tied to economic growth. For long-term institutional investors, this presented some very attractive opportunities.

*Data Source: Morningstar, Inc.; base = 100; data as of 1/31/18

Through 2016 and early 2017, the sector recovered partially from the earlier losses as oil prices improved, and it was during this early period that we increased our exposure. The outlook for the sector was still somewhat murky in the short-term due to uncertainty about Organization of Petroleum Exporting Countries (“OPEC”) production and little apparent consolidation in the industry; many of these firms, despite being fairly significant in terms of market cap, were young enough to still be headed by charismatic founders who were reluctant to surrender their positions in mergers or acquisitions. Operations of the sector as a whole continued to be strong, though there were some distribution cuts primarily among companies which had taken on excessive leverage.

The sector finished 2017 on a weak note. This was due in part to the modest decline in oil prices but also due to the competition from technology stocks which outperformed so much that the energy sector in general was of little interest to mainstream equity managers. Despite all of this, distributions remained stable amongst the firms we held which provided us with greater confidence as we moved into the new year.

During 2018, we are very optimistic about pipeline MLPs for the following reasons:

  1. Global economic growth has continued to strengthen over the second half of 2017 and appears to be the strongest in many years.
  2. As a consequence, bolstered by stable OPEC limits on supply, economic growth has increased oil demand which in turn has led to a steady increase in the oil price to new highs from the 2016 low. This means that there will be demand for increasing volumes from US production to be moved by pipelines to domestic and/or international markets.
  3. Many firms have simplified their corporate structures, and we are confident that the actions which have been taken or will be taken will be sufficient to satisfy potential investors in the specific names we own.
  4. There is broad agreement within the industry that it is important to avoid excess capacity and debt and to increase operating efficiencies and profitability. We have sought to own individual companies which seem aware of this.
  5. Consistent with increasing growth in the US economy, generalist portfolio managers are looking beyond technology stocks to sectors of the market which lagged but are showing improving fundamentals; energy is prominent among these.
  6. Finally, we continue to see strong and improving fundamentals among the individual companies whose securities we hold combined with very attractive valuations following the sector weakness of late 2017.

For fixed income investors who are looking for an income-focused strategy that offers a diversified return stream, we believe pass-through securities offer an attractive alternative to traditional bonds. Trust and Fiduciary Income Partners (“TFIP”) is a sub-advisor to the LoCorr Spectrum Income Fund. TFIP allocates amongst six primary sectors based on the most attractive risk-based return. At the moment, they see tremendous opportunity in pipeline MLPs.

Mutual fund investing involves risk. Principal loss is possible. The Funds are non-diversified, meaning it may concentrate its assets in fewer individual holdings than a diversified fund. Therefore, the Funds are more exposed to individual stock volatility than a diversified fund. The Funds invest in foreign investments and foreign currencies which involve greater volatility and political, economic and currency risks and differences in accounting methods. These risks are greater for emerging markets. The Funds may make short sales of securities, which involves the risk that losses may exceed the original amount invested. Investing in commodities may subject the Funds to greater risks and volatility as commodity prices may be influenced by a variety of factors including unfavorable weather, environmental factors, and changes in government regulations. Investing in derivative securities derive their performance from the performance of an underlying asset, index, interest rate or currency exchange rate. Derivatives can be volatile and involve various types and degrees of risks, and, depending upon the characteristics of a particular derivative, suddenly can become illiquid. Investments in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term debt securities. Investments in Asset Backed, Mortgage Backed, and Collateralized Mortgage Backed Securities include additional risks that investors should be aware of such as credit risk, prepayment risk, possible illiquidity and default, as well as increased susceptibility to adverse economic developments

The Funds may invest in small- and medium-capitalization companies which involve additional risks such as limited liquidity and greater volatility. The Funds may also invest in lower-rated and non-rated securities which present a greater risk of loss to principal and interest than higher-rated securities. ETF investments are subject to investment advisory and other expenses, which will be indirectly paid by the Fund. As a result, the cost of investing in the Fund will be higher than the cost of investing directly in ETFs and may be higher than other mutual funds that invest directly in stocks and bonds. ETFs are subject to specific risks, depending on the nature of the ETF. A Fund's real estate portfolio may be significantly impacted by the performance of the real estate market generally, and the Fund may be exposed to greater risk and experience higher volatility than would a more economically diversified portfolio. Property values may fall due to increasing vacancies or declining rents resulting from economic, legal, cultural, or technological developments. Investments in Limited Partnerships (including master limited partnerships) involve risks different from those of investing in common stock including risks related to limited control and limited rights to vote on matters affecting the Limited Partnership, risks related to potential conflicts of interest between the Limited Partnership and the Limited Partnership's general partner, cash flow risks, tax risk, dilution risks and risks related to the general partner's limited call right. Underlying Funds are subject to management and other expenses, which will be indirectly paid by the Fund.

Diversification does not assure a profit nor protect against loss in a declining market.

Before you invest in the LoCorr Funds, please refer to the prospectus for important information to consider carefully about the investment company, including investment objectives, risks, charges and expenses. You may also obtain a hard copy of the prospectus by calling 1.855.LCFUNDS (1.855.523.8637). The prospectus should be read and considered carefully before you invest or send money.

The Funds are offered only to United States residents, and information on this site is intended only for such persons. Nothing on this web site should be considered a solicitation to buy or an offer to sell shares of the Funds in any jurisdiction where the offer or solicitation would be unlawful under the securities laws of such jurisdiction.

Correlation is a statistical measure of the degree to which the movements of two variables (stock/option/convertible prices or returns) are related.

The LoCorr Funds are distributed by Quasar Distributors, LLC

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