Electronic income

Revenue Opportunities and Defensive Play: MLP and Utilities

Jhe first half of 2022 has been abysmal for investors with broad equity markets down more than 20% as inflation proved persistent and the outlook for a soft landing deteriorated. The 10-year Treasury yield fell from 1.51% at the end of 2021 to 3.02% as of June 30. Even energy – the only sector with price increases in HY22 – came under pressure last month as recession fears (and profit taking) weighed on the space. With inflation at 8.6% and returns for many income equity investments around 3%, this is clearly a challenging environment for income investors. For those looking for higher yields, the recent volatility in energy could be an opportunity to take advantage of attractive returns from MLPs and complement existing portfolio exposures, namely utilities.

The energy sell-off in June put MLP index returns above their ten-year averages for the first time since December 2021. The Alerian MLP Infrastructure Index (AMZI) was up 8.16% at the end of June compared to its ten-year return. average of 7.61%. Importantly, the outlook for MLP distributions remains strong given strong fundamentals, continued free cash flow generation, and commodity price levels that are encouraging measured growth for U.S. oil and gas producers. There has been no reduction in the Alerian Energy Infrastructure Index Suite for three consecutive quarters, and on an annual basis, over 80% of the AMZI by weighting increased payouts (read more). Notably, leading MLP Enterprise Products Partners (EPD) today announced a 2.15% sequential increase in distribution.

Not much has fundamentally changed for MLPs in the past month, but MLP index returns are 110 basis points higher than at the end of May. The upcoming earnings season will give leadership teams the opportunity to highlight positive trends at the company level and could help serve as a catalyst for the space. It’s also worth noting that MLPs (and energy infrastructure in general) are expected to hold up better than other energy sectors in a downturn given their paying business models (read more).

Income investors positioning themselves for the worst have likely already shifted more of their portfolio to utilities given their defensive stance. Utilities largely held up, down just 0.56% year-to-date through June 30 on a total return basis, as represented by the S&P 500 Utilities Index (S5UTIL). However, at the end of June, the yield of utilities was practically in line with that of the 10-year Treasury (3.05% against 3.02%). Investors looking for higher yields could shift some of their exposure to utilities into MLPs depending on their risk tolerance. The ten-year standard deviation for MLPs is about double that of utilities, but in energy, MLPs are a more defensive sub-sector given their fee-based business models. In other words, MLPs generate stable cash flow, but stock values ​​can be volatile as the space trades largely more in line with oil prices and energy stocks. A 70-30 mix of utilities and MLP would have returned 4.58% at the end of June. Moreover, the five-year and ten-year correlations between S5UTIL and AMZI are modest at 0.35 and 0.30, respectively. For investors seeking both income and a more defensive positioning, supplementing exposure to utilities with MLPs could be an attractive solution.

AMZI is the underlying index of the Alerian MLP ETF (AMLP) and the ETRACS Alerian MLP Infrastructure Index ETN Series B (MLPB).

Current returns versus history

In June, MLP yields rose to levels above their ten-year averages for the first time since December 2021. Intermediate and MLP yields are below their five-year averages.

Returns for the Dividend Dogs index suite are generally above their five-year averages, with the exception of SDOGX. SDOGX has held up well this year thanks in part to its equal weighting system, which provides greater exposure to the energy and utilities sectors relative to broad equity benchmarks.

Multiple screens for dividend sustainability, including assessing cash flow, EBITDA, and debt ratios, help ensure reliable income from sustainable dividend indices.

Closed-end funds have been under pressure from rising interest rates and current returns for all three CEF indices are above their historical averages.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.