AMZA - MLPs Stand Out As Rising Rates Challenge Income Plays
2023-10-28 08:00:00 ET
Summary
- Higher interest rates have challenged many income investment categories this year, but yield will likely remain appealing to investors given broader market uncertainty.
- Among income investments, MLPs stand out for both generous yields relative to bonds and noticeable outperformance relative to the S&P 500 year-to-date.
- For income investors, MLPs and midstream may be particularly attractive given less sensitivity to rising interest rates and diversification benefits.
Originally published on October 24, 2023
With higher interest rates, yield is easier to find than it has been in some time, but many traditional income investments have come under pressure in 2023.
Some income categories have been negatively impacted by rising rates, while also facing greater competition from bonds and money market funds providing more attractive yields.
Today’s note looks at performance for income investments and why MLPs and midstream deserve a second look in the current environment.
Income investments largely lag the broader market in 2023, except MLPs
Traditional equity income investments and bonds are mostly lagging the S&P 500 this year, which has gained over 15% on a total-return basis through October 17 thanks largely to the so-called Magnificent Seven stocks.
This is a stark reversal from 2022 when income investments largely outperformed the loss in the broader market ( read more ). The chart below shows year-to-date performance and yields for several income investments.
Rising interest rates have driven some of the weakness seen for income investments. Clearly, rising rates pressure the value of bonds. Meanwhile, higher borrowing costs represent headwinds for closed-end funds (CEFs), which often use leverage ( read more ).
Similarly, more expensive debt is a challenge for capital-intensive utilities, which are investing in renewable energy and see project returns potentially squeezed by a higher cost of capital.
The rise in interest rates has also led to increased competition among yield investments. REITs and utilities are now yielding less than corporate bonds.
Unless investors are anticipating a rebound in these sectors, it may be difficult for them to assume the greater risk of these equity investments when quality fixed income investments offer higher yields.
Among income investments, MLPs stand out for both generous yields relative to bonds and noticeable outperformance relative to the S&P 500 year-to-date.
Income remains attractive in an uncertain macro environment; consider MLPs and midstream
Though performance for income investments has been mixed at best this year, investors may continue to be drawn to yield given prevalent market uncertainty.
Recession risk is still a concern, the path for interest rates remains unclear, and geopolitical tensions are heightened. In challenging environments, yield can be particularly attractive as it supports total return.
With this backdrop, investors may consider giving MLPs and midstream another look. The outlook for dividends from this space remains very strong, with companies largely growing their payouts ahead of inflation as they generate free cash flow ( read more ).
MLPs and midstream have not been negatively impacted by rising interest rates and tend to do well in periods of elevated inflation.
From a portfolio diversification standpoint, MLPs and midstream have modest long-term correlations with other income investments like bonds (near 0.0) and utilities (~0.3 – 0.4).
Even with a three-year annualized total return of 42.6% as of October 17, MLP valuations are not stretched. AMZI is trading in line with its three-year average forward EV/EBITDA multiple of 8.8x.
Bottom Line
Higher interest rates have challenged many income investment categories this year, but income is likely to continue to appeal to investors given broader market uncertainty. For income investors, MLPs may be particularly attractive given yields more generous than corporate bonds and less sensitivity to rising interest rates.
AMZI is the underlying index for the Alerian MLP ETF ( AMLP ) and the ETRACS Alerian MLP infrastructure Index ETN Series B (MLPB). AMNA is the underlying index for the ETRACS Alerian Midstream Energy Index ETN ( AMNA ). CEFX is the underlying index for the Invesco CEF Income Composite ETF (PCEF).
Disclosure: © VettaFi LLC 2023. All rights reserved. This material has been prepared and/or issued by VettaFi LLC ("VettaFi") and/or one of its consultants or affiliates. It is provided as general information only and should not be taken as investment advice. Employees of VettaFi are prohibited from owning individual MLPs. For more information on VettaFi, visit www.vettafi.com
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MLPs Stand Out As Rising Rates Challenge Income Plays