Exchange traded products tracking master limited partnerships such as Alerian MLP ETF (NYSEArca: AMLP) and JPMorgan Alerian MLP Index ETN (NYSEArca: AMJ) have dropped below their 50-day moving averages for the first time this year as interest rates tick higher.
MLP ETFs have been gathering assets in recent years due to their strong performance, diversification properties and attractive yields in a low-rate environment for bonds. AMLP has seen inflows of nearly $1.4 billion so far this year after amassing $2.6 billion last year, according to IndexUniverse data. The ETF currently holds $6.2 billion in total net assets.
Yet MLP products have come under a bit of pressure the past two weeks as Treasury yields rise. AMJ was down more than 2% at one point on Wednesday.
MLPs are companies that focus on the processing, storage and transportation of oil and natural gas. They pay out most of their net income to investors.
“There are several reasons for investors in MLPs to be concerned if interest rates rise,” writes Justin Carley at the Motley Fool.
He said MLPs would not be as attractive relative to U.S. Treasuries if rates continue to rise. “Secondly, MLPs are highly leveraged and higher interest rates would hurt the bottom line more than other industries,” Carley added.
Next page: MLPs’ cost of capital and Gundlach’s warning on higher rates
Still, the recent declines in MLP ETFs have been muted relative to other high-yield sectors such as preferred shares and real estate investment trusts.
Darren Schuringa, founder of Yorkville Capital Management, in a recent Barron’s interview said if an MLP’s borrowings are short-end dated, and interest rates start to move up, borrowing costs go up. The firm manages Yorkville High Income MLP ETF (NYSEArca: YMLP). [A Closer Look at Master Limited Partnership ETFs and ETNs]
Meanwhile, the prospectus for Alerian MLP ETF warns that rising interest rates are an industry-specific risk for the fund.
“A rising interest rate environment could adversely impact the performance of MLPs. Rising interest rates could limit the capital appreciation of equity units of MLPs as a result of the increased availability of alternative investments at competitive yields with MLPs,” according to AMLP’s prospectus. “Rising interest rates also may increase an MLP’s cost of capital. A higher cost of capital could limit growth from acquisition/expansion projects and limit MLP distribution growth rates.”
Noted portfolio manager Jeff Gundlach in May said that MLPs would feel the pain if interest rates rise because they have a lot of leverage and interest-rate risk, Barron’s reported.
JPMorgan Alerian MLP Index ETN
Full disclosure: Tom Lydon’s clients own AMLP.