New investors reviewing the recent performance of MLPs might be scared off for good. But the reality is that market volatility is not quite what it seems, because MLPs have maintained or boosted distributions despite a collapse in oil prices. According to a Think Advisor interview with Jeremy Held, director of Research & Investment Strategy for ALPS Portfolio Solutions, to the patient go the spoils.
“Long-term investors, if can they can withstand the volatility … will be rewarded for staying the course in the asset class,” Held explained.
What new investors need to look for in MLPs
The most important thing to keep in mind for new investors looking into the MLP space for the first time is that fundamentals matter more than oil commodity price volatility. In the long term, the fundamentals for MLPs, particularly midstream companies, will remain intact because demand for oil will continue to be prevalent. So too will the growing need for energy infrastructure.
This is the reason why midstream MLPs have withstood oil price drops in the last two years. For instance, oil prices ranged from $92 to $117 a barrel and distributions increased by 7.3 percent in 2013, while oil prices dropped to between $59 to $106 per barrel and distributions improved by 6.8 percent in 2014. This has been further evidenced in the last 12 months as oil has dipped to about $43 to $60 a barrel, but distributions have increased by 7.5 percent. In fact, midstream distributions have increased by 1.9 percent in Q2 2015, up from 1.5 percent Q1.
Therefore, new investor concerns about declining oil commodity prices need to be put into context. What matters most is the stability of the distribution, something midstream MLPs have maintained in all market conditions.
MLPs as a hedge for savvy investors
MLPs offer investors real assets that act as a great hedge against inflation and market conditions. This is due to the fact that most midstream MLPs have long-term contracts that are indexed for inflation. In fact, MLPs operating pipelines were allowed to raise their fees 4.58 percent. In July, federally-mandated tariff increases were implemented for pipelines, which include the Producer Price Index. Therefore, with oil prices likely to stabilize with the domestic production boom combined with the increasing demand for oil, midstream MLPs are positioned for growth in the next few years.
The bottom line is distribution growth
MLPs are down by over 18 percent since January, making many lose faith in the sector. New investors see the record lows in oil prices, and may be scared off from the energy sector as a whole. But it is important to note that the Alerian MLP Index has grown by 4.3 percent this third week of August, showing that the sector has recovered a substantial portion of the losses it incurred with the price collapse.
Supporting this rebound is Darren R. Schuringa, chief investment officer for Yorkville Capital, who explained that midstream MLPs are yielding 7.5 percent. What this means is that the pullback in the sector was not related to the fundamentals of these midstream companies. So with these midstreamers unaffected by market volatility, distributions have been maintained and exceeded.
For context among new investors to the sector, the spread between MLPs and U.S. Treasuries is a good comparison. This is due to the fact that historically, when spreads between MLPs and U.S. Treasuries have been wider than 5 percent, MLPs produced positive returns over the next twelve months 100 percent of the time. This is what makes the current market conditions a great entry point for new investors.
But when infrastructure MLP distributions are put under review, it is clear that with 11.5 percent growth year-over-year, investors are provided with high yielding assets that are volatility resistant.