Higher interest rates since 2022 have made it easier to find yield. However, as the Fed recently cut baseline rates by 50 basis points and signaled further cuts, income investors could increasingly turn to midstream/MLPs to help offset lower yields from fixed income holdings. Today’s note looks at recent performance for income investments and why MLPs and midstream could entice investors as interest rates trend downward.
Midstream/MLPs Have Outperformed and Still Offer Compelling Yields
In 2022, when the Fed first raised interest rates, bonds came under pressure given the inverse relationship between interest rates and bond prices. Corporate bond yields rose with higher interest rates as bond prices fell, but even at their peak, investment-grade bond yields were still below those provided by midstream/MLPs (read more).
Rising rates also challenged equity income investments such as REITs and Utilities as investment-grade fixed income offered more competitive yields with lower risk (read more). Higher borrowing costs from higher interest rates also impacted equity income investments, particularly utilities, which are capital intensive.
Relative to REITs or Utilities, midstream/MLPs are less sensitive to interest rate movements and have other performance drivers. As REITs and Utilities fell, the Alerian MLP Infrastructure Index (AMZI) rose 62.6% and the Alerian Midstream Energy Select Index (AMEI), which includes MLPs and US and Canadian midstream C-Corps, rose 38.0% on a total-return basis from the end of 2021 through 2023.
In late 2023 and into 2024, fixed income investments, REITs, and Utilities rebounded as the market began to anticipate interest rate cuts (albeit rate cuts generally took longer to materialize than initially expected). As shown in the chart below, income investments have seen positive total returns year to date. REITs and Utilities have recovered noticeably, while bonds have seen more modest gains.
Importantly, midstream/MLPs have seen strong performance, while continuing to offer attractive yields relative to the other categories shown. Even high-yield bonds, which had been offering yields north of 8% earlier this year, have seen their yield dip below those of midstream MLPs as rates have come down.
Looking ahead, midstream/MLP yields are expected to remain more attractive relative to peers as interest rates fall (read more). To be clear, midstream/MLPs are not bond substitutes, and as equities, midstream/MLPs carry more risk than fixed income investments.
Why Energy Infrastructure?
Energy infrastructure companies are involved in processing, transporting, and storing energy commodities such as oil and natural gas and typically provide services under long-term, fee-based contracts. Midstream/MLPs’ fee-based business models result in stable cash flows that have historically supported robust dividend payouts.
After years of significant capital spending to facilitate growing US energy production, energy infrastructure companies began to generate meaningful free cash flow in 2020. Companies are using their significant free cash flow to return cash to shareholders through dividend growth and opportunistic buybacks, having already reduced leverage and strengthened their balance sheets (read more). Companies in AMZI and AMEI have largely grown their dividends in recent years, and there has not been a dividend cut in either index since July 2021 (read more).
AMZI is the underlying index for the Alerian MLP ETF (AMLP) and the ETRACS Alerian MLP Infrastructure Index ETN Series B (MLPB). AMEI is the underlying index for the Alerian Energy Infrastructure ETF (ENFR) and the Alerian Energy Infrastructure Portfolio (ALEFX).
Related Research:
Is Your Income Stream Too Dependent on the Fed?
MLPs Stand Out as Rising Rates Challenge Income Plays
2Q24 Midstream Dividend Recap: MLPs Drive Growth
Total Midstream/MLPs Repurchases Top $1 Billion in 2Q24
Can MLPs/Midstream Benefit From Lower Interest Rates?
Midstream/MLPs Raising the Bar With Lower Leverage
For more news, information, and analysis, visit the Energy Infrastructure Channel.
Vettafi.com is owned by VettaFi LLC (“VettaFi”). VettaFi is the index provider for AMLP, MLPB, ENFR, and ALEFX for which it receives an index licensing fee. However, AMLP, MLPB, ENFR, and ALEFX are not issued, sponsored, endorsed, or sold by VettaFi, and VettaFi has no obligation or liability in connection with the issuance, administration, marketing, or trading of AMLP, MLPB, ENFR, and ALEFX.
