Hard Landing For High Flying MLP Funds

October 12, 2015

What's Hurting MLPs
Jay Hatfield, co-founder and president of Infrastructure Capital Advisors, and portfolio manager of the InfraCap Active MLP ETF (AMZA), said the sector is "tainted by these upstream MLPs, and that's made investors extremely nervous, and has affected the sector negatively."

Because upstream MLPs are closely tied to oil production, they're more likely to get hurt in the drop in oil prices.

Emily Hsieh, director of operations at Alerian, says the issue in 2015 is that people are not necessarily sure how long oil prices will remain at current levels.

"The fear now is that crude prices will stay where they are, and MLPs won't grow anymore," she said.

The income that MLPs generate still makes them attractive, particularly now, says Dan Heckman, national investment consultant for U.S. Bank Wealth Management. The yield spread between MLPs and the 10-year U.S. Treasury note has widened to as much as 500 basis points, versus the historical average of around 300 bps.

"We think the higher-quality MLPs will do fine over a longer-term cycle," Heckman said, adding that he believes MLPs are starting to bottom.

There is some debate as to whether any interest-rate hike by the Federal Reserve will pinch MLPs. Some argue the Fed won't raise rates high enough to entice yield-loving investors. But in late August, Barron's cited comments by Jeffrey Gundlach, founder of DoubleLine Capital, who said MLPs will suffer under a rate hike because of the leverage some MLPs use.

Phil Blancato, chief executive officer of Ladenburg Thalmann Asset Management, with $2.2 billion under management, says that despite MLPs being underwater, his firm is sticking with the investment. He still likes MLPs from a portfolio diversification standpoint, and that they can be a "solid dividend payer in a portfolio." He has a small allocation to the MLPX.

Blancato says the U.S. energy outlook is still positive, as energy infrastructure in the U.S. is vastly underserved and that demand in the U.S. and globally remains up, even with sluggishness in the global economy. Further, earnings for midstream MLPs remain solid, with all of them still paying dividends.

He would change his mind if the U.S. slipped into a recession and true energy demand fell, Blancato says. A sustained drop in crude oil prices would also give him pause.

"I think that producers in the U.S. are profitable north of $30 a barrel. Our opinion is, even with crude at six-year lows, U.S. producers are profitable here because of the efficiency of the fracking technology. That said, there's still room for the bloodletting to continue," he said.

Chuck Self, chief investment officer of iSectors, says investors should at least "have a toe in the water" for MLPs, noting that "the market has priced in a lot of pain."

What might be working against MLPs is that—until the late August equity sell-off—the stock market was focused on growth, rather than value, he says. Given the sector's volatility, he would recommend no more than 5% for a portfolio allocation.

Morningstar's Goldsborough says that given that only a handful of MLP ETFs are even five years old, one should consider the risk of investing in a sector so young.

"It's always more interesting to see how funds behave across a full market cycle. That's certainly an issue for MLPs," he noted.

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