Why MLPs Still Look Attractive despite Their Recent Falls
In this article, we’ll analyze the relative performances of the Alerian MLP Index (or AMZ) and the S&P 500 Index (or GSPC) over the last ten years.
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From the end of the financial crisis through the end of 2014, MLPs clearly outperformed the S&P 500 Index due to the US energy shale boom. MLPs invested heavily in growth projects and continued to grow their distributions while maintaining attractive yields. This activity resulted in increased MLP exposure by both institutional and retail investors.
At the end of 2014, investors started dumping anything related to oil and natural gas due to the fall in US energy prices. Even MLPs, which generally have lower commodity price exposures and fee-based revenues, saw major sell-offs. These sell-offs were attributed to the overbuilding of pipeline capacity, falling MLP throughput volumes, and general negative sentiments toward the energy sector. As a result, AMZ underperformed GSPC from 2014 to 2016.
In February 2016, AMZ was trading close to the lows it saw during the financial crisis. It’s risen 18% since its February low, resulting in a YTD (year-to-date) price rise of 2.0%. Including a 7.5% yield, AMZ has returned 9.5% YTD on a total return basis. At the same time, GSPC has returned 8.0% on a total return basis.
Benefits of investing in MLPs
Although MLPs have underperformed the S&P 500 Index over the past two years, investors can still consider them an investment option, especially considering benefits such as high yield investments and high distribution growth. We’ll discuss these two factors later in the series.
AMZ also sees diversification benefits. Its correlation with other indexes is low, implying that the inclusion of MLP securities in your portfolio could help to diversify your risk. AMZ has had average correlations of 0.5 and -0.18 with the S&P 500 Index and the S&P/BGCantor U.S. Treasury Bond Index in the past three years.
Investors looking to take advantage of the recent US shale energy boom can invest in energy-related MLPs, which represent the majority of the MLP universe. Specifically, midstream companies have huge growth potentials, considering the massive demand for energy infrastructure required to support the expected rise in supply and demand of energy commodities in the long term.