From David Fabian: The multi-year plunge in oil and natural gas prices has been partially arrested in 2016, and one high yield investment sector is riding the recovery wave higher.
Master limited partnerships, or MLPs, are operators of pipeline, storage, and energy infrastructure assets primarily focused in North America.
These publicly traded entities enjoy a special tax advantage that allows them to return a large portion of their operating income to shareholders in the form of dividends. As such, they are coveted by income investors for their above-average yields and alternative business models compared to conventional dividend stocks or bonds.
Rather than choosing to own individual companies, one way to play this sector is through a diversified exchange-traded fund. The largest of which is the Alerian MLP ETF (AMLP). This exchange-traded fund is home to the 25 largest and most liquid MLPs trading in the market today.
AMLP has 9.3 billion in total assets and charges a management fee of 0.85% annually. Top holdings include: Enterprise Products Partners LP (EPD), Magellan Midstream Partners LP (MMP), and Energy Transfer Partners LP (ETP).
The combination of holdings and their associated weighting within AMLP produces a current yield of 7.60% annually. Dividends are distributed to shareholders in the fund on a quarterly basis.
In 2015, AMLP lost -27.33% in total return because of the dive in global commodity prices and concomitant expansion in credit spreads. This year, the fund has gained a total return of 12.76% and is up more than 55% from its February lows as energy prices lead the way higher.
One factor that has helped facilitate this rebound in energy stocks is the lack of suitable yield in other areas of the global marketplace. Many sovereign nations are still mired in ultra-low to negative interest rates. Investors looking to diversify into alternative assets or enhance their yield targets may be attracted to the beaten down nature of MLPs and their associated high dividends. It’s worth noting thatETF.com fund flow data confirms AMLP has added $1.17 billion in net new assets on a year-to-date basis.
Other exchange-traded funds in the MLP space have experienced similar price trends. The Global X MLP ETF (MLPA) has gained nearly 18% this year as investors regain a sense of confidence in high yield stocks. MLPA has $340 million in total assets and charges one of the lowest expense ratios in this category at 0.45%.
Investors considering accessing the world of MLPs in their portfolio should be aware of a few key risks. The first being that there is no free lunch in the income-producing world. It should be assumed that a higher yield comes with an associated higher level of volatility and risk of capital.
MLPs should also not be viewed as an alternative to fixed-income or with any kind of “bond-like” approach. They carry far different characteristics than bonds and may not be suitable as a substitute for core fixed-income exposure. Those who owned MLPs from their lofty 2014 levels through the early-2016 trough experienced just how far these assets can fall relative to other income-producing opportunities.
This article is brought to you courtesy of FMD Capital.