2013 was pretty volatile for interest-rate sensitive sectors like Master Limited Partnerships (MLPs) thanks to the Fed tapering talks which pushed up interest rates substantially. Despite this sluggish trend, MLPs delivered a decent performance finishing the year with average gains of about 16%.
With the Fed finally deciding on a soft QE cut-back ($10 billion per month) from this month, investors are concerned whether MLPs will able to march ahead in 2014 or not.
The Fed chairman, Ben Bernanke also commented on December 18 that the bond buying program will be curtailed in phases in 2014 and may finally end by late 2014, if improvement in the labor market matches the regulatory body’s expectation. Since then, the downside risk in the MLP sector has increased.
Are MLPs at Risk?
MLPs are publicly traded partnerships generally engaged in the transportation, storage, production, or mining of minerals and natural resources. MLPs often operate pipelines or similar energy infrastructures that make it an interest-rate sensitive sector.
MLPs catch investor eye as these do not pay taxes at the entity level and are thus able to pay out most of their income (more than 90%) in the form of dividends like the REIT firms. Investors looking for higher income levels outside the traditional bond sources bet on these products (read:Boost Income and Growth with MLP ETFs).
Following the ‘Taper’ announcement, interest rates started to show an uptrend which in turn sent the bond yields higher. Though the latest U.S. job report was shockingly weak and pushed the bond yields lower instantly, this does not mean that the Fed will modify its Taper plan only on the basis of one-month data.
In fact, barring this single data, all other economic indicators are pointing to the rapid pickup in the economy which in turn indicates further taper in the course of 2014. Also, even after a downward correction due to the weak job data, yield on 10-year treasury bonds again inched up to 2.84% as of January 13, 2014.
Quite expectedly, in a rising rate environment, MLPs fall out of favor among yield-seeking investors. Plus, if interest rates rise, MLPs will have to pay higher for the huge chunk of borrowed money which may in turn force them to lower their dividend payout ratio.