As interest rates rise, many investors are re-considering if MLPs, master limited partnerships which invest in American energy infrastructure, still belong in their portfolios. Delegate Advisors President Andy Hart shared his views on the role of MLPs in a portfolio in a recent articlein U.S. News & World Report.
“MLPs were popular holdings for income-starved investors when interest rates were at rock bottom and equity markets delivered higher yields than much of the investment grade fixed income universe. Depending on the investment, MLPs could kick off yields of 6 or 8 percent or even more, making them good alternatives when U.S. Treasury notes yielded 1 percent or less. But with the Federal Reserve raising interest rates, yields on U.S. Treasury notes are starting to rise too,” U.S. News & World report explains. “Because of rising rates, many market strategists say it’s time to get rid of investments like MLPs. Other experts, however, tell investors not to overreact.”
Hart is on the side of not overreacting. He tells U.S. News & World Report that he’s less concerned about the Fed raising rates because short-term interest rates don't affect MLPs as much as long-term rates. The difference in yields between 10-year U.S. Treasury notes and MLPs, known as the spread, is attractive, Hart says. Historically, the spread between the two instruments has ranged between 280 and 300 basis points. The MLPs he likes yield 8 percent versus the nearly 3 percent yield from Treasurys. That 500-basis-point difference “is a very nice spread and has a lot of cushion.”
Rising interest rates aren’t the only reason some investors are losing interest in MLPs – there is also confusion among investors about how they are taxed. The Federal Energy Regulatory Commission recently said that certain interstate MLP pipelines are ineligible for some tax breaks, Hart explains. But investors misunderstood the situation as the MLP's most important feature, its tax status as a pass-through instrument, remains intact. Pass-through investments don't pay corporate taxes. Instead they "pass through" profits and losses to the owners and investors, who are responsible for paying taxes on their individual portion of the MLP.
To read more about MLPs see the full U.S. News & World Report article here.