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Why MLPs provide excellent risk-reward for investors

Alerian MLP vs. BBB High Yield SpreadsEnlarge GraphOver the last 13 years, there has never been an occasion where master limited partnership (MLP) spreads have been this wide to BBB high yield corporate indices. Traditionally, investors have sought out higher yielding asset classes, such as corporate bonds with credit ratings below BBB and MLPs, when nearing retirement. At this point, the BBB corporate high yield trade seems to be crowded whereas there is less capital flowing into MLPs, without justification.

The chart above, displays the MLP Alerian index, a market weighted MLP index of the largest 90 MLPs in the United States vs. the BBB high yield index. Both have been adjusted for the risk free rate , the U.S. 10-year treasury. Since 1999, the difference in spreads  has not been as wide as it is today, at ~280 basis points, or 2.8%.

Low BBB corporate yields show that investors are clearly anxious to find higher yielding asset classes. Retirees continue to suffer from financial repression, a symptom of the Federal Reserve’s consistent efforts to keep interest rates low, through quantitative easing. Investors who are more familiar with high yield bonds have driven spreads to 20 year historic lows, finding comfort in low default rates and a strong refinancing market. Demand for corporate credit has left other asset classes, like MLPs and non-agency mortgage REITs, relatively undervalued.

In this environment, MLPs such as the Kinder Morgan MLP (KMI), APL, BPL, and BWP may outperform BBB corporate credit. Moreover, the AMLP ETF may outperform the JNK ETF (high yield bond market) in 2013 because of increased spending on oil infrastructure in the U.S. and the relatively high spread differential between the two asset classes. We will discuss oil infrastructure spending’s impact on MLP yields in subsequent articles.

The Realist Discussions

  • stud

    this is massive divergence and the group shud be sold