Why Are Advisors Flocking to Midstream?

47.9% of financial advisors surveyed said they plan to increase their allocation to midstream, in addition to the 18.3% of respondents who said they do not currently allocate to midstream but are considering doing so, according to ‘Energy Infrastructure 2022 Outlook: Inflation and Income Opportunities.’

Of the advisors surveyed, 42.3% said they are using midstream for income generation. The energy sector ranks first in average dividend yield, according to ETF Database.

38% of respondents are using midstream for total return. The relative stability of dividend income can help drive a higher total return. The total return for income-oriented indexes has often outperformed the broader market during high inflation years, according to Roxanna Islam, associate director of research at Alerian.

In 2021, the price return of the S&P 500 was 26.9%, compared to the price return of 29.8% for the Alerian Midstream Energy Index (AMNA); however, when looking at the total return, the S&P 500 returned 28.7% and the AMNA returned 38.4%. 

35.2% of advisors surveyed are using midstream for diversification. The sector is less affected by commodity prices because its revenue is derived from long-term, fee-based contracts, offering a way for investors to diversify their portfolios.

Opportunities to diversify a portfolio are increasingly hard to find as broad indexes become more concentrated in their top holdings.

Midstream also offers tax advantages, which is a reason that 21.2% of respondents are allocating to the sector. The pass-through structure of MLPs provides significant tax efficiency. The majority of MLP distributions are generally tax-deferred, with the remainder taxed as ordinary income in the current year, according to Alerian.

Finally, 16.9% of respondents are using midstream as a way to hedge against inflation.

Equities that pay dividends are typically better-positioned in an inflationary environment than the broader equity market or fixed income investments.

While higher rates mean higher borrowing costs for existing variable debt and new debt issuances, this may also be less of an issue for midstream/MLPs, particularly relative to the past. 

Leverage has trended lower over time as many companies have focused on debt reduction in recent years. Additionally, midstream capital spending has come down meaningfully since peaking in 2018 or 2019 when companies were investing heavily to facilitate production growth, according to Stacey Morris, director of research at Alerian.

Production volumes are still recovering and below pre-pandemic levels, which has contributed to lower growth capital spending. Reduced capital spending and less debt in the capital structure should help mitigate the impact of rising rates on midstream borrowing costs, according to Morris.

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