But if I knew how to manage my portfolio safer and smarter than most hedge fund managers, I could realistically grow my wealth.
Master limited partnerships rely highly on external capital to fund growth
Master limited partnerships or MLPs are specially structured entities that must pay out most of the cash they generate to unitholders. So MLPs rely especially on external funding sources (as opposed to internally generated cash) to execute growth projects and acquisitions. Because of this, the state of the capital markets (generally referring to the equity and bond or loan markets) is an important factor in determining whether an MLP can find the money to participate in growth-oriented activities.
Debt yields have broadly decreased over the past few months
Since late August, the cost of debt across most of the MLP spectrum has declined. For example, in the large-cap space, Enterprise Products Partners (EPD) 5.25% Notes due 2020 were yielding roughly 3.4% in late August, compared to ~3.0% currently. The yield on Plains All American Pipeline’s (PAA) 5% Notes due 2021 was ~3.7% in late August, compared to ~3.3% currently. The yield on Kinder Morgan Energy Partners (KMP) 6.85% Notes due 2020 was ~3.8% at the end of July, compared to ~3.3% currently.
Plus, the cost of debt for most small and mid-cap MLPs decreased over the past few months. For example, the yield on Targa Resources Partners (NGLS) 6.875% Notes due 2021 was ~5.5% in late August, compared to ~4.4% currently. The yield on Genesis Energy’s (GEL) 5.75% Notes due 2021 was ~6.0% at the end of August, compared to ~5.6% currently. The yield on MarkWest Energy’s (MWE) 5.5% Notes due 2023 was ~5.9% in late August, compared to ~5.4% currently.
Despite the beginning of Fed tapering, rates are likely to remain low in the near term
Current interest rates are close to historic lows. This is because since the financial meltdown of late 2008, the Federal Reserve has taken many measures to keep rates low to support the U.S. economy. On December 18, 2013, the Fed announced that it would begin to scale back its purchases of Treasuries and mortgage-backed securities on the open market, citing signs of a stronger U.S. economy. The “tapering” of its asset purchase program had caused markets to fear a spike in interest rates. However, the Fed’s language indicates that it plans to approach a scale-back of its program very cautiously and gradually, and only if U.S. economic data supports it. The market expects interest rates to remain low in the near term, which also keeps debt funding costs for MLP names low. Low borrowing costs for MLPs are a positive, as they mean cheap funding to pursue growth projects and acquisitions. For more on Fed tapering, see Why the Fed’s tapering announcement affects MLPs and Learn to love the taper: What you must know from the Fed minutes.
Another important piece of the cost of capital for companies is the cost of equity, which we discuss further in the following part of this series.
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