MLP Update: A Rise in Treasury Yields

by: , Managing Partner and Chief Investment Officer, Cushing Asset Management

An MLP Update Following a Rise in Treasury Yields

Master Limited Partnerships (MLPs) and some other yield-centric investments, such as utility stocks, gave back a portion of their prior year-to-date gains recently as 10-year Treasury yields moved up near 1.80% this month from 1.6% at the end of September. To get his take on the state of things, we checked in with Jerry Swank, Head of Cushing Asset Management, which sub-advises several MainStay Mutual Funds.

Yields and Returns on Yield-Centric Investments (Yield, Returns for this Month, YTD and YOY)

 

mlp-update-rise-treasury-yields-markets-101916-chart

Source: Bloomberg. Dividend yield and returns as of 10/14/16. Past performance is no guarantee of future results, which will vary. It is not possible to invest directly in an index. MLPs are represented by the Alerian MLP Total Return Index (AMZX Index). REITs are represented by the FTSE NARIET All Equity Total Return REIT Index (FNERTR Index) a free float adjusted market cap weighted index including all tax qualified RIETs listed on the NYSE, AMEX, and NASDAQ. Telecom, Utilities, and Consumer Staples are represented by the S&P 500 Total Return capitalization weighted GICS Level 1 sector indices – SPTRTELS Index, SPTRUTIL Index, and SPTRCONS Index respectively. Dividend yield is the 12 month dividend yield calculated by Bloomberg. It is the sum of gross dividend per share amounts that have gone ex-dividend over the prior 12 months, divided by the current stock price.

Based on valuations and growth projects, Jerry and his team believe the types of MLPs they zero in on, should be an attractive space for long-term investors seeking income from outside of their bond portfolios. MLPs currently yield 7.35% according to Bloomberg on September 30. The team looks for three main attributes in a general partner: (1) distribution sustainability, (2) contract sanctity and (3) access to capital for growth.

Outlook

As long as inflation remains largely in check, there is probably a ceiling as to how high Treasury yields will go and, by extension, how much of a headwind they might pose on yield-centric investments. Jerry remarked it wasn’t that long ago when MLPs were under the influence of another macro force: energy prices. During a 7-quarter energy price swoon in 2014-2016, midstream MLP prices largely decoupled from their underlying cash flows and revenue streams and moved in tandem with energy prices.

Looking ahead, the investment team is moderately constructive that oil and natural gas prices will grind slightly higher this year and next as supply and demand move towards balancing out. In the case of natural gas, it’s the first time Cushing has been positive on the price outlook in 4.5 years.

The team believes solid 3Q earnings results will help investors pay attention to company fundamentals a little bit more and macro forces a little bit less. Jerry stressed that the long-term fundamentals and starting valuations should provide long-term investment tailwinds.

Conclusion

MLP prices have diverged from their cash flows with the latest rise in Treasury bond yields. The current yield spread between MLPs and the 10-Year U.S. Treasury rate is approximately 600 basis points, compared to the long-term average yield spread of 300-350 basis points. Based on the current yield spread, we believe there is significant room for that spread to compress before MLPs feel upward yield pressure from rising interest rates. Solid 3Q earnings results might help investors re-balance their focus on micro and macro forces when evaluating this high-yielding asset class.

All investments are subject to market risk, including possible loss of principal.

Treasury securities are backed by the full faith and credit of the U.S. government as to payment of principal and interest if held to maturity. Interest income on these securities is exempt from state and local taxes.

MLPs and other natural resources sector companies are subject to certain risks, including, but not limited to fluctuations in the prices of commodities; the highly cyclical nature of the natural resources sector may adversely affect the earnings or operating cash flows of the issuers; a significant decrease in the production of energy commodities would reduce the revenue, operating income, and operating cash flows of MLPs and other natural resources sector companies and, therefore, their ability to make distributions or pay dividends.

Midstream MLPs gather, process, and transport natural resources.

Contract Sanctity refers to the principle that the parties to a contract, having duly entered into it, must honor their obligations under it.

For more information about MainStay Funds®, call 800-MAINSTAY (624-6782) for a prospectus or summary prospectus. Investors are asked to consider the investment objectives, risks, and charges and expenses of the investment carefully before investing. The prospectus or summary prospectus contains this and other information about the investment company. Please read the prospectus or summary prospectus carefully before investing.

New York Life Investment Management LLC engages the services of federally registered advisors. Cushing® Asset Management, LP is unaffiliated with New York Life Investments.
MainStay Investments® is a registered service mark and name under which New York Life Investment Management LLC does business. MainStay Investments, an indirect subsidiary of New York Life Insurance Company, New York, NY 10010, provides investment advisory products and services. Securities distributed by NYLIFE Distributors LLC, 30 Hudson Street, Jersey City, New Jersey 07302.

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Jerry Swank

Managing Partner and Chief Investment Officer, Cushing Asset Management

Jerry V. Swank founded Swank Capital in 2001 and its wholly owned SEC-registered investment adviser in 2003. He has over 40 years of experience in investment management and research analysis. Mr. Swank was formerly President and CEO of

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