Master Limited Partnerships Hit By Energy, Credit Concerns

The deleveraging in the energy sector continues and one area that is going down with the ship is Master Limited Partnerships (MLPs). These high yield energy-related securities fell heavily during October and are once again free falling over the glut of energy stock piles and plunging Crude Oil (WTI – Quote) prices.

Industry titan Alerian MLP ETF (AMLP) is a $9 billion fund that tracks 25 of the largest Master Limited Partnerships in the marketplace. Looking at the chart below, you can see that the recent drop in share price has erased nearly all its gains for the year. That’s a steep slide in a relatively short period of time when the majority of these companies’ profits are based on a toll-road style business model rather than direct correlation to commodity prices.

alerian master limited partnership amlp chart 2014

Markets often tend to overshoot their boundaries when a specific sector is under fire. In the case of MLPs, they face the stigma of being energy-related. Their tax structure allows them to pass the majority of profits to shareholders in the form of dividend payments. AMLP has a current yield of 6.6%.

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In effect, this niche area of the income-generating market is guilty by association with a credit and energy deflation environment.

The iShares High Yield Corporate Bond ETF (HYG) has also seen steady declines. Investors continue to worry about the global deleveraging of junk bonds. Oil & Gas debt makes up approximately 14% of HYG at this time and has been a significant drag on the credit sector.

hyg high yield price chart 2014

So where does this sector go from here and how can you play it?

If you have been holding MLPs for some time you are likely in a well-established cost basis and are more interested in the income rather than the short-term price fluctuations. It’s too early to say whether there is cause for greater concern or if this is another fast blip like we saw in October.

Investors looking to establish new positions should be watching this sector closely at this juncture. Commodity prices have slid significantly off their highs and valuations are more attractive than they have been in quite some time. While these funds can be volatile, they offer attractive yields and non-correlated price action that may appeal to a diversified income portfolio with a more aggressive angle.

Those with a more conservative taste may want to take a look at the First Trust North American Energy Infrastructure Fund (EMLP). This actively-managed ETF takes a unique approach of combining both traditional utility stocks and MLPs. The defensive aspect of utilities and their continued outperformance has made this a less volatile play this year. The tradeoff is that a broader energy infrastructure focus begets a lower yield of just 2.39%.

This alternative asset class is certainly one to watch into 2015 as the situation with energy prices and related credit continues to shake out. It’s a unique niche, so investors need to do their homework on master limited partnerships before adding to their portfolio. Thanks for reading.

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No position in any of the securities mentioned at the time of publication.  Any opinions expressed herein are solely those of the author, and do not in any way represent the views or opinions of any other person or entity.