Bernstein: Energy & MLPs In Bubble Environment

March 04, 2015

CEO of Richard Bernstein Advisors talks about the energy space.

[The following is an excerpt from an article that originally appeared on Alpha Think Tank at and is republished here with permission.]

Richard Bernstein is the chief executive officer and chief investment officer of U.S.-based Richard Bernstein Advisors (RBA), an investment advisory firm that uses a top-down approach to investing, focusing on macro trends rather than individual stock selection. Before founding RBA in 2009, Bernstein was the chief investment strategist at Merrill Lynch. He was voted to Institutional Investor magazine's annual "All-America Research Team" 18 times, and is one of only 50 analysts inducted into the Institutional Investor "Hall of Fame." His book "Style Investing: Unique Insight into Equity Management" is widely viewed as the seminal book on style-oriented investment strategies.

Bernstein recently sat down with to talk about overlooked risks in the master limited partnership (MLP) space due to plunging oil prices. At our recent Inside ETFs conference, you spoke about some concerns with MLPs. What dangers do you see there? What's your take on MLPs these days?

Richard Bernstein: Our view on energy in particular is that it's been our contention that the energy sector was actually in a bubble. It's funny how people have been looking for bubbles all over the place, and the one that was actually kind of staring them in the face nobody believed was the bubble, and still doesn't believe it's a bubble. It has all the characteristics of a traditional financial bubble.

MLPs have become one of the favorite ways for people to get at income through the energy sector. What's interesting is that for the underlying MLP universe of companies, the fundamentals have changed dramatically in the last 10 years, largely because of this bubble environment. They're not even free cash flow positive anymore, which I find interesting, that people would be so interested in an income-oriented vehicle, where the underlying companies are free cash flow negative. That just makes no sense to me at all.

What that means is that they've become more and more dependent on outside financing for their cash flows. We just think that adds an element of danger that people really aren't aware of. 

At the same time, everybody's convinced that MLPs are not correlated to energy prices. That's just not true. They have about a 65 or 70 percent correlation to oil prices. The fundamentals are eroding in this space. Everybody believes that oil going from $100 to $50 is going to have no impact. We find that very hard to believe. The fundamentals of these companies are no place where they were five or 10 years ago; they're much, much weaker.

Everybody says, well, won't there be good MLPs? Of course, when an industry gets in trouble, higher-quality companies outperform on a relative basis versus lower-quality companies. But the key thing in what I just said was "on a relative basis." The question is, do you even want to be in the MLP space at all? 

Our contention is that it's probably much riskier than people think. There's a huge gap between the perception of what these companies are all about and the reality. What's your view on oil? We're at $45-50 for WTI now. What do you think about 2015 and beyond?

Bernstein: We don't forecast oil prices, per se. But it's a little disconcerting to us that everybody's looking for a quick bounce in the energy sector, under the suspicion that this is just a temporary retracement in energy prices. We think this is akin to the way people were talking about technology stocks in the summer of 2000, when technology stocks' prices fell quite dramatically and everybody said, "Oh, it's just temporary and you should buy them now." Well, that didn't quite work out.

That's kind of what it sounds like today, where everybody is rushing to either buy the stocks or, in many cases, buy the debt of some of these companies. We still think there's much more risk than people think. On the credit side of the equation, high-yield bond issuers within the oil patch have definitely taken it on the chin. Do you see that as an isolated event that's related to energy frothiness? Or do you see it as part of a larger credit bubble?

Bernstein: I don't think it's a credit bubble overall within the entire economy, but certainly within the energy sector, credit was pretty free flowing. A couple of years ago, we were joking in the presentations we used to give. We'd say, "Well, all you have to do is walk into a bank these days and whisper the word 'fracking' and they would throw money at you." That was two or three years ago.

That's what was going on, and that took place in the high-yield bond market. So, what you're seeing is a reassessment of the credit risk of the companies within the energy sector. That's only natural to see that. Spreads probably got way too narrow. They're going to normalize in one form or another.

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