MLPs and REITs are highly regarded as two of the best sectors for finding high-yielding equity due to the corporate income tax-exempt pass-through structures; however, one has historically fared better in a rising rate environment.
The Federal Reserve last month raised the benchmark federal funds rate by a quarter percentage point to a range between 0.25% and 0.5% from near zero. Most Fed officials projected pushing it up to at least pre-pandemic levels, which would be consistent with raising interest rates at every scheduled meeting this year.
Midstream and MLP indexes have modest positive correlations of 0.24 and 0.25, respectively, with the 10-Year Treasury Yield when looking at weekly correlations for the last decade. Over the same period, REITs have had a correlation of 0.02, according to Stacey Morris, CFA, director of research at Alerian.
The correlation data suggests that midstream and MLPs should fare better than REITs in a rising rate environment — a theory that has proved true in historical examples. Overall, MLPs and midstream outperformed REITs in periods where Treasury yields were increasing.
Over a three month period, the ETRACS Alerian Midstream Energy Index ETN (AMNA ) and the JPMorgan Alerian MLP Index ETN (AMJ ) are up 18.61% and 12%, respectively, according to each firm’s website.
MLPs and midstream may also benefit from reduced capital spending and less debt in the capital structure, helping to mitigate the impact of rising rates on midstream borrowing costs.
Midstream capital spending has come down meaningfully since peaking in 2018 or 2019 when companies were investing heavily to facilitate production growth. Production volumes are still recovering and below pre-pandemic levels, which has contributed to lower growth capital spending, according to Morris.
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