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Why a spike in Treasury yields could affect your master limited partnership portfolio

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Investors in master limited partnerships (MLPs) closely watch Treasury yields

Investors who hold master limited partnership (MLP) stocks often monitor interest rates on Treasury bonds because many investors hold MLP stocks for the distribution or “yield” component of the securities. U.S. government Treasury yields are relevant because if rates on the bonds increase, investors should expect rates on MLPs to increase as well. This is because many view U.S. Treasuries as one of the safest yielding investments in the financial universe, and if the rates on Treasuries increase, the yield required from MLPs (and all other yield instruments) should also increase. When the yield on MLPs increases, the price and valuation of MLPs decrease.

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Additionally, when yields on instruments such as Treasuries decrease, the fall also pushes investors seeking current income into other instruments, such as corporate bonds and MLPs. Therefore, as Treasury yields decrease, yields across the bond sector and higher dividend stocks such as MLPs also tend to decrease.

Last week, the yield on the ten-year U.S. Treasury increased by 40 basis points

The yield on the benchmark ten-year Treasury increased sharply last week, rising 40 basis points, from 2.13% to 2.53% for the week ended June 21. The yield on the ten-year Treasury has been consistently on the rise since early May, when it was trading at around 1.65%, compared to the current levels of ~2.50%. The rate on the ten-year Treasury is the highest it’s been since mid-2011.

In the context of a longer term, Treasury yields have been close to all-time lows for a while, though recently yields have backed up significantly. The following graph shows historic yields on the ten-year Treasury from the beginning of 2001 to the present.

The low yields we’ve seen over the past few years mostly affect the Federal Reserve pumping money and liquidity into the financial system. However, last week, Fed Chairman Ben Bernanke commented that the Fed’s stimulus program could end as strength returns to the economy. The following graph shows the yields on the Alerian MLP Index versus ten-year Treasury yields.

Treasury yields could push investors to require more yield out of riskier investments such as MLPs

Except for the period of the financial crisis, where investors pulled money out of riskier investments such as equities (including MLPs) and poured it into cash and Treasuries, MLP yields have often moved in tandem with Treasury yields.

Last week, the yield on the ten-year Treasury increased significantly, which was negative for MLPs. Furthermore, over the past several weeks, the yields on Treasury instruments increased to the highest points in over a year, which was a negative medium-term catalyst for the rate-sensitive MLP sector. Lastly, from a longer-term perspective, rates remain relatively low. This has resulted in a long-term positive for MLPs. If rates eventually rise, for example to pre-recession levels of 4% to 5%, the rise could be negative for MLPs and the Alerian MLP Index (AMLP). Major names in the index include Enterprise Products Partners (EPD), Kinder Morgan Energy Partners (KMP), Magellan Midstream Partners (MMP), and Plains All American Pipeline (PAA). Therefore, owners of MLPs should understand rate movements and how they affect MLPs.

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