Investors who have been relying on high-yield assets to generate some extra cash should lean toward master limited partnerships and related exchange traded funds in a rising rate environment.
Mark Litzerman, co-head of Real Asset Strategy at Wells Fargo, pointed out that MLPs outperform other high-yield assets like real estate investment trusts and utilities in a rising interest rate environment, reports Amey Stone for Barron’s.
Nevertheless, MLP options like JPMorgan Alerian MLP Index ETN (NYSEArca: AMJ) and Alerian MLP ETF (NYSEArca: AMLP) are not entirely free of rate risks as the companies need to rely on debt financing fore new projects, so higher rates translates to greater costs. The two ETFs still pulled back as benchmark 10-year Treasury yields rose off its February low.
“If interest rates rise again, the cost of capital for MLPs would increase, which could result in lower distributions,” according to Morningstar analyst Abby Woodham. “MLPs have historically struggled during rising rate markets, but not to the extent of other rate-sensitive investments like REITs or high-yield fixed income. During the bond sell-off of 2013, MLPs dipped but quickly recovered and went on to post strong returns for the year to date through the end of the year and for 2014 through the end of the second quarter.”
Additionally, Litzerman argues that diversified midstream partnerships could continue to grow as the U.S. energy boom is still ongoing, despite the plunge in prices.
Even though the U.S. oil rig count fell to 922 in early March from a peak of about 1,609 back in October, oil production has increased to 9.4 million barrels per day, a 40-year high, Bloomberg reports.