- MLPs participated in the recent sell-off following the Fed's "taper talk."
- Over longer periods, however, MLPs have not been correlated to interest rate changes.
By Brian Watson, CFA, Senior Portfolio Manager
May and June will not be soon forgotten by investors. Due to the Federal Reserve's "taper talk" that began on May 22, most risk assets declined in value through May and June. Yield-sensitive investments, in particular, were hard hit, and master limited partnerships (MLPs) were not immune to this sell-off. From its May 22 closing price through June, the Alerian MLP Index was down 2.4%. Other asset classes fared worse. The Dow Jones U.S. Utilities Index was down 3.1%, while the S&P 500 Index was down 2.8%, and the FTSE NAREIT Equity REIT Index was down 8.8%.1
Most investors are painfully aware that in a panic, almost everything sells off. For MLP investors, however, the turmoil around the taper talk must have brought the following question to the forefront: What happens to MLPs when interest rates increase consistently, an environment that many expect going forward?
Our portfolio managers have an average 13 years of direct MLP experience with individual tenures reaching back to the mid-1990s. Our team has also spent considerable time studying the relationship between MLPs and interest rates. In the short-run, MLPs, like most yield-sensitive assets, are affected by big rate moves. For example, in April 2004, former Federal Reserve Chairman Alan Greenspan announced that it would increase the Fed Funds rate from its then level of 1.00%. Over the next month, the 10-year U.S. Treasury rate increased nearly 1.00% and the Alerian MLP Index declined about 13%.
But over a longer time frame, there has been no material correlation between changes in interest rates, as measured by the 10-year U.S. Treasury rate, and MLP yields, as measured by the Alerian MLP Index. Let's go back to the 2004 example. Yes, MLPs sold off in that first month. However, by the end of September 2004, the Alerian MLP Index had recovered to where it was trading prior to the spike, even as the Federal Reserve continued to raise the Fed Funds rate. In fact, from May 31, 2004 through June 30, 2006, as the Fed Funds rate increased from 1.00% to 5.25%, the cumulative total return experienced by the Alerian MLP Index was nearly 42%.2
There are possible explanations for this lack of correlation. First, historically MLPs have grown their distributions on a generally consistent basis, while bond coupons inherently remain the same. This seems to have created a natural upward bias in MLP performance relative to fixed rate instruments. Second, while there are always exceptions, the underlying business of energy infrastructure-related MLPs is not largely affected by rapid interest rate moves. Most MLPs utilize fixed rate debt for a majority of their borrowing. Therefore, after the initial trading reaction to interest rate spikes, MLP performance has tended to return to reflecting the underlying fundamentals.
Recall that MLPs do not simply seek to offer a relatively compelling yield. They may also offer growth potential. As domestic oil and natural gas production continues to benefit from a powerful renaissance, we believe the possibility exists for MLPs to continue to grow their businesses, and in turn, their distributions to shareholders.
1. Bloomberg, 6/28/13.
2. Bloomberg, 6/27/13.
Past performance does not guarantee future results.
The S&P 500 Index is a capitalization-weighted index of 500 stocks intended to be a representative sample of leading companies in leading industries within the U.S. economy.
The Alerian MLP Index is a composite of the 50 most prominent energy MLPs that provides investors with an unbiased, comprehensive benchmark for this emerging asset class.
The Dow Jones Utilities Index is a stock index that keeps track of the performance of 15 prominent utility companies.
The FTSE NAREIT Equity REIT Index consists of certain companies that own and operate income-producing real estate that have 75% or more of their respective gross invested assets in the equity or mortgage debt of commercial properties.
The indices are unmanaged and cannot be purchased directly by investors.
Investing in MLPs involves additional risks as compared to the risks of investing in common stock, including risks related to cash flow, dilution and voting rights. MLPs may trade less frequently than larger companies due to their smaller capitalizations which may result in erratic price movement or difficulty in buying or selling. MLPs are subject to significant regulation and may be adversely affected by changes in the regulatory environment including the risk that an MLP could lose its tax status as a partnership. Energy infrastructure companies are subject to risks specific to the industry such as fluctuations in commodity prices, reduced volumes of natural gas or other energy commodities, environmental hazards, changes in the macroeconomic or the regulatory environment or extreme weather. Distributions from MLP funds have been classified as "return of capital" which reduces the investor's adjusted cost basis. Diversification does not guarantee profit or protect against loss.
OFI Global Asset Management consists of OppenheimerFunds, Inc. and certain of its advisory subsidiaries, including OFI Global Asset Management, Inc., OFI Global Institutional, Inc., OFI SteelPath, Inc. and OFI Global Trust Company. Our investment strategies may be offered through various investment products that are advised or managed by one or more investment advisory entities comprising OFI Global.
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