By Tyler Wilton, CFA, Investment Specialist for Liquid Real Assets, DWS
A volatile backdrop
Recently in 2020, Master Limited Partnerships (MLPs) have experienced quite significant volatility, following multiple years of above average volatility for the space. While volatility and uncertainty has been a major theme driving several asset classes thus far in 2020, the MLP market has stood out notably. With balance sheet challenges, weak performance, and ongoing volatility, it may be time for investors to consider alternative options for existing MLP exposure. We believe there are two primary solutions with stable and attractive long-term investment potential, specifically (1) Global Infrastructure, and (2) Real Assets. As seen in the chart below, MLPs began to struggle since oil collapsed in 2014, while more diversified options like global infrastructure and real assets have seen more stable volatility levels.
Volatility mounted in 2018 following critical FERC regulatory policies which significantly changed the MLP market going forward, and the uncertain landscape in 2020 has amplified MLP volatility. As seen in the above rolling 3-year volatility chart, some of the key figures are:
- From the end of 2012 to June 2020, average 3-year volatility was roughly 18% for MLPs, compared to 11% for global infrastructure and 10% for real assets.
- By the end of 2019, 3-year volatility skyrocketed to 44% by mid-2020, the highest level in history.
- At this same time, global infrastructure 3-year volatility was significantly lower at 15% and 14% for real assets.
MLP market activity
Prior to 2014, the Midstream Energy space was experiencing a cyclical boom from the “North American Energy Renaissance” which contributed to very strong and consistent performance for MLPs. This was driven in part by growing global demand for energy, as well as new supply coming to market in the United States that would require significant infrastructure build-out to support this growth and meet demand. For years, MLPs provided a reliable investment based on stable cash flows and growth. However, recent volatility and significant events exposed potential risks for long-term investors, leading many to consider suitable replacement options. We believe uncertainty within the MLP universe will remain a concern for many years, and investors need to be well prepared for significant disruption when investing.
These aforementioned events have brought into question the viability of the MLP vehicle. We believe many investors have already taken action, as seen in the below fund flows chart below. Passive MLP vehicles have recently seen consistent outflows from rising volatility and challenging performance, which we expect to continue. The chart below depicts historical net flows on a rolling 60-day period for the top six MLP-focused ETFs/ETNs based on assets under management (AUM), and cumulative relative performance of the Alerian MLP Index versus broader equities, represented by the S&P 500 Index.
As shown above, passive MLP products (represented by a proxy of the six largest MLP vehicles by AUM – blue bars) began seeing consistent outflows in early 2018 – a clear anomaly, historically speaking. The “orange” line in the chart depicts MLPs relative performance to the S&P 500 Index. MLPs delivered very attractive relative returns until late 2014, which correlates to when crude oil prices began their descent.
The narrow focus of MLPs may lead to greater volatility and less investment opportunities given the limited scope of MLPs which operate specifically in the energy sector and solely based in the United States. Given the lack of diversification for MLPs, we believe global infrastructure or real assets should be considered based on a wider opportunity set spanning multiple sectors, regions, and countries, coupled with a stable, long-term investment thesis. The lack of diversification combined with mounting external factors within the MLP universe may provide a strong case against long-term investments in the space.
In summary
Overall, we believe it is time for investors to evaluate existing MLP exposure as the viability of the MLP structure remains uncertain, evident by ongoing conversions to traditional C-Corps as well as privatizations. Over the past five years, MLPs have faced an array of challenges, enough for investors to re-visit the rationale for MLP exposure and also consider more suitable options to replace MLPs, primarily (1) Global Infrastructure, or (2) Real Assets.