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Rising to the Challenge

By Elliott H. Gue on Jun. 26, 2015

Over the past half-decade, the Alerian MLP Index has delivered impressive outperformance, fueled by growth opportunities created by the shale oil and gas revolution and investor demand for above-average yields in a low-rate environment.

The Alerian MLP Index has held up better than most energy subsectors since oil prices began to tumble last summer, giving up only 17.8 percent of its value, compared with the 49.7 percent loss posted by the Bloomberg North American Independent E&P Index and the Philadelphia Oil Service Sector Index’s 33.5 percent drop.

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This resilience relative to other energy equities stems in part from the perceived safety of long-term, fee-based contracts that predominate in the midstream industry.

Nevertheless, this basket of 50 prominent master limited partnerships (MLP) has underperformed thus far in 2015, posting an 8.8 percent loss after factoring in distributions.

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This recent downside reflects a number of factors, including the Alerian MLP Index’s outperformance relative to other energy stocks last year, the market’s growing concern about rising interest rates and worries that the slowdown in drilling activity will limit future growth opportunities.

Long the province of individual investors seeking a reliable income stream, the upsurge in US oil and gas production driven by the shale revolution transformed this niche security class into more of a growth vehicle.

Although buy-and-hold investors income historically have gravitated toward MLPs for their above-average yields, the huge growth opportunity created by the shale oil and gas revolution shifted the focus from accumulating growing payouts to yield compression—or price appreciation that outstrips distribution increases.

Given investors’ negative sentiment toward the energy patch and the diminished growth outlook for many MLPs, faster money that entered the space in search of outsized price appreciation may head for areas that offer more lucrative returns.

The March 23 issue of Energy & Income Advisor warned that much of this technical downside would focus on Enterprise Products Partners LP (NYSE: EPD) and other blue-chip names that figure prominently in the more than 80 fund products that offer significant or pure-play exposure to MLPs. (See Risk Check.)

The outperformance of midstream giant Kinder Morgan’s (NYSE: KMI) stock relative to Enterprise Products Partners underscores this technical risk.

Since June 30, 2014, Enterprise Products Partners’ units have pulled back by 19.7 percent, in line with the Alerian MLP Index’s 17.8 percent drop.

As the largest MLP by market capitalization, Enterprise Products Partners has a 17 percent weighting in the Alerian MLP Index and features prominently in the 81 long-oriented mutual funds, closed-end funds, exchange-traded funds and exchange-traded notes that offer significant exposure to this security class.

 

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