Rising Interest Rates One Risk Associated with Investing in MLPs

Indie Research

While we have long extolled the investing virtues of MLPs (master limited partnerships), just like any investment, these stocks do carry risk.

The two biggest risks that could affect MLPs as a group are a change in the tax status of the structure and rising interest rates. While Canadian trusts suffered from the surprise elimination of the trust structure, we don't foresee the U.S. doing the same, as the expansion of the trust structure that led to the new Canadian legislation was addressed in the 1980s by the U.S. government by limiting the structure to natural resource plays. (Interestingly, the NBA's Boston Celtics became an MLP in 1986.)

However, there has been talk that President Obama will propose eliminating the tax structure of MLPs as part of a larger corporate tax overhaul. While we think the risk of MLP's losing their tax-advantaged status anytime soon is slim, it is nonetheless a risk to be aware of.

Meanwhile, as yield-based investments, MLPs carry interest rate risk and typically underperform in rising interest rate environments, and when investors have heightened fears about the economy, the risk spread between Treasuries and MLPs can also widen, hurting the stock price of MLPs.

When talking about risk, it is also worth mentioning that MLPs tend to have secondary stock offerings quite often to help fund growth given that most cash flow is paid out to unitholders in the from of distributions. The dilutive nature of these offerings usually cause stock prices to take a temporary hit.

In the long run, these risks have usually proven to be small hiccups, but MLPs that have the ability to grow their dividends more quickly tend to outperform during periods of increasing interest rates or widening risk spreads.

In a new 70-page report, BullMarket.com examines the various valuation metrics used to evaluate MLPs (and LLCs), gives it top picks in 12 MLP subsectors, and answers some common questions, such as whether MLPs could face the same political backlash as former Canadian Energy trusts such as Baytex Energy (BTE).

Among the stocks featured in its report are Rentech Notrogen (RNF), Northern Tier Energy (NTI), Hi-Crush Partners (HCLP), Kinder Morgan Energy (KMP), Vanguard Natural Resources (VNR), Regency, (RGP), Stonmor Partners (STON), and many others.

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