Buy low. Buy value. Buy panic. Buy MLPs.
Income Growth Advisors, LLC has continued to deliver solid returns for its clients even though the Alerian MLP Total Return Index is down 19.81% over the trailing twelve months. This rare negative performance is primarily due to the historic correction in oil prices which began late last June. Brent crude oil prices appear to have stabilized and are trading 45% below their peak. This was the third worst decline in crude oil history and led to a sharp decline in capital spending in the oil industry and in the growth of the US shale boom. Additionally, MLPs have also been hampered by rising rates. Since yields on the 10 year US Treasury have risen from 1.6% to 2.40%, income generating assets have lost some of their appeal, and this too has been a headwind for MLPs. Lastly, the technical default by Greece led to global market weakness in recent days which explains why June was a particularly bad month.
MLPs offer an excellent value. Underlying trends in the US shale boom are improving and MLPs’ 6.5% tax advantaged yields are compelling. Though yields have increased and the Federal Reserve will continue to taper its unprecedented accommodation policy, we believe most of that damage is priced into MLPs.
Three basic investment rules now apply to MLPs: Buy low. Buy value. Buy panic.
• Since the beginning of the year, the yield on the 10 year US Treasury has backed up from 1.6% to nearly 2.5%. While the market anticipates higher yields as the Federal Reserve reduces its unprecedented accommodation, we believe much of the interest rate correction in the MLP sector has occurred and that a slow gradual rise in rates will occur over the next three years with nominal negative impact to MLPs.
• MLPs still offer a very attractive tax advantaged income offering. The index currently yields 6.5%.
• Relative to the 10 year benchmark MLPs trade at a high spread. Currently the MLP index yields 414 basis points over the US Treasury. Historically, when investors have bought MLPs at 400 BPs over the US Treasury, they have been rewarded.
• As the domestic energy sector adjusts to the lower oil and gas prices, we expect a resumption in growth and confidence in the US shale renaissance. With that resumption of growth, the MLP sector should enjoy solid price appreciation as spreads normalize and higher distribution growth prospects are again priced into MLP valuations.
• Following last year’s historic decline in oil prices, MLPs declined due to the direct and indirect influence of the commodity’s price decline on the sector.
• Natural gas prices are under great pressure which historically is when a commodity sector bottoms.
We believe the worst in commodity price behavior is behind us and that much of the impact of higher rates is priced into the MLP market. From these levels, we would expect low double digit returns for investors in MLPs driven by a growing tax advantaged yield of 6.5% and distribution growth in the 4-7% range for the next few years. Relative to other asset classes, we believe that MLPs offer one of the most attractive investment options for investors seeking stable growing income for retirement and financial stability.
Sincerely,
Tyson Halsey, CFA