Quarterly Report – March 31, 2008

April 18, 2008

The economic difficulties that began with the collapse of the mortgage market, especially subprime, spread to other sectors of the economy in the first quarter. Nevertheless, the Fund’s ability to experience a favorable record during that period in the first quarter was another example of the benefits of our “energy chain” strategy, namely, to take advantage of diversification and a larger pool of investment opportunities offered by as many as eight energy sub sectors.

During the quarter, as oil and gas prices rose above $100/bbl and $8.00/mmcf, respectively, we increased our holdings in E&P, oil service, and a select group of infrastructure stocks, including McDermott International, Chicago Bridge and Iron, Equitable Resources, Southwestern Energy, Quicksilver Resources, and National Oilwell Varco, to name a few. We also raised the Fund’s investment exposure in Master Limited Partnerships (MLPs) because of our belief that this fundamentally attractive group of infrastructure companies is significantly undervalued. We believe the macroeconomic environment for MLPs is very positive. Historically, MLPs tend to outperform during market downturns, as they are considered a flight to quality due to their high visible dividend (distribution) growth, especially if interest rates are going down. In addition, the current macro environment of relatively strong energy demand and positive commodity prices has been the backdrop for record profits and growth opportunities. Although, we have been early in adding to our MLP exposure (many of our companies are now yielding around 8%, with visible dividend (distribution) growth also around 8%), we remain confident that the strong fundamentals will prevail. Importantly, in our opinion, midstream MLPs such as Williams Pipeline, Atlas Pipeline, and Markwest are beneficiaries of the higher oil and gas prices. This macro backdrop, as well as the reduction in interest rates, has contributed to a much improved market performance since March. Also, we understand that there is a significant amount of institutional capital on the sidelines to buy into this space.

Energy Merchants and non-regulated utilities continue to be contributors to our performance. There is increased reaffirmation of our power thesis as forecasts show excess electricity reserve margins are shrinking across the U.S. Coal and nuclear power plant additions continue to be political “hot buttons” and state and local governments have discouraged infrastructure investment by opting for price controls rather than allowing competitive market pricing. Therefore, we are very bullish on companies that are long non-regulated electricity generation because they are the major beneficiaries of tightening power prices. In addition, we would not be surprised to see an expansion of natural gas generation plants due to the immediate need for environmentally friendly power. Therefore, during the quarter, we increased our investment in the merchant, unregulated utility theme. With coal and nuclear plant construction having major political difficulties, and fears of regulators establishing price caps, there is uncertainty about new generation additions. As such, existing power plant net asset values (NAV) should continue to rise (especially with any signs of a hot summer). With that in mind, we added Calpine, which has the largest portfolio of natural gas plants.

In terms of positioning, while we continue to remain upbeat about our sector’s fundamentals, we cannot help but take into account the ongoing more volatile stock market headwinds. We ended the quarter net long 71%, balancing attractive valuation opportunities with a very challenging economic environment. This is up from 57% as of December 31, 2007.

Finally, with the Republican Presidential nominee announced, and the Democratic field narrowed to two, here are some quick observations:

1. The three remaining candidates are all more pro-environment and, as such, could support some sort of carbon regulation
2. If the Democratic nominee wins, capital gains and dividend taxes could rise (a negative for utilities, but a positive for Master Limited Partnerships)

In summary, we continue to be very positive about the long-term energy outlook. As value investors, we continue to take advantage of equity pullbacks and employ all available tools to capitalize on the opportunities and reduce volatility.

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.

« Library »

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.