Last Yield Standing

For those living off a fixed income, the current interest environment is, to say the least, quite unsavory. Extending out to 30 years on the Treasury curve only fetches a paltry 3% (and a taxable 3% at that). This has interest-starved investors loading up on junk bonds and leveraging up bond portfolios (risk parity anyone?). Yet, both of those approaches may be ill-timed based on current interest rate levels.

Another choice is to venture beyond the traditional, fixed income space. Indeed, investors have been getting into everything from high dividend stocks to REITs in search of that ever-allusive yield. This relentless search for income seems to have bid down yields across all asset classes. Well, almost all. There is one yield play that looks to be holding strong – master limited partnerships.

A master limited partnership (MLP) refers to a type of company structure that combines the tax and liability benefits of limited partnerships with the flexibility of publicly traded corporations. The MLP structure is generally reserved for companies engaged in natural resources. Examples include the exploration, production, transportation, and storage of natural gas and oil. The US government grants MLPs favorable tax treatment as a way to promote energy-related activities.

For example, MLPs can avoid income tax at the corporate level as long as they abide by certain rules. One of those rules is to distribute the majority of their income to limited partners (the MLP investors), typically about 90%. These distributions result in higher yields compared to other equity-type securities. According to Alerian, MLPs have historically delivered an average yield of 7.69%. Currently, they yield 5.69%. This is shown in the chart below.

At first glance, this looks like the same old story: yields spiked around 2009 and have since fallen to below average levels. However, after closer inspection, MLP yields may not be as low as they appear. When considering MLP yields, it makes sense to evaluate them in relative terms. For example, the spread of MLP yields over the 10 year Treasury yield is currently around 400 basis points. Historically, the spread has averaged around 300. This is shown in the table below.

With this in mind and all else being equal, we could say that MLPs are attractively valued in relative terms. For example, though investors may be able to find 6% yields in high yield bonds, the 400 basis point spread over the 10 Year Treasury is lower than the historical average spread of 600 basis points.

There are a number of different ways to access MLPs, including picking individual MLP issues. That would, of course, require some expertise with MLPs and security selection. A simpler approach would be to access one of the various MLP exchange-traded products (ETPs) that are available. The ETPs have made it fairly easy to gain broad exposure to the MLP space in a cost-efficient manner.

In summary, as yields continue to fall on all fronts, MLPs may be one of the last yield strongholds still standing. Like other assets, current MLP yields are below average levels. However, they do seem less low on a relative basis. There is no shortage of ways to gain exposure. If you do, just be sure to take positions in moderation and as part of a properly diversified portfolio appropriate for your needs.

Victor K. Lai, CFA

This blog is for informational purposes only. Nothing on this blog constitutes investment, tax, or legal advice. You should conduct proper due diligence and / or consult with professional advisers before taking any investment action.