Wall Street types are always on the lookout for can’t-miss, slam-dunk, win-win investments that they can either load into their own portfolios or stuff into their clients’ accounts. These are often known as “story plays” because they come complete with a yarn explaining why they’re can’t-miss, etc., etc.
Over the last couple of years, one of the biggest plays has been master limited partnerships in the oil industry, MLPs for short. These have been promoted intensively by, among others, Jim Cramer of CNBC, with some investment advisors calling them ideal for retirement portfolios. The argument was that they were oil investments that were largely immune to the decline of oil prices.
Having read this far, you probably can see the punchline coming.
This year, MLPs have gotten hammered. As a group they’re down about 28% from their all-time high last year. In 2015 thus far the leading MLP index investment, the Alerian MLP exchange traded fund, is down more than 16%, compared with a roughly 1.5% gain in the Standard & Poor’s 500 and 6.67% gain in the Nasdaq index. Investment consultant Danielle Sandusky, writing on Seeking Alpha, is calling this “the great MLP meltdown of 2015.”
The lesson is that investment brokers never tell you the whole story--possibly because they don’t know it themselves. Here’s the story on MLPs, and how they came apart at the seams.
MLPs started to get pitched a couple of years ago to investors looking for higher fixed-income yields than conventional bonds, without undue risk. They were safer than high-yield or “junk” bonds, it was said, often with higher yields.
The beauty part was that although they were investments in oil, they didn’t involve a bet on oil prices themselves. That’s because they typically represented oil distribution infrastructure such as pipelines, not production. Oil producers had to pay them fees to carry their oil no matter the price of crude.
In summary: Their prices were disconnected from the price of oil stocks, they looked like bonds, and their exposure to oil price declines was modest.
“It’s a great story,” observed Josh Brown of Ritholtz Wealth Management on his Reformed Broker website over the weekend. "If only it wasn’t complete and utter...." You can fill in the rest of his line as you wish.
The pitfalls emerged soon after the peak last year. To begin with, not all the MLPs had such secure fixed-fee arrangements as the best of them. While it may be true that many are immune to the direct movement of oil prices, they’re not immune to the indirect effect. Their fees are often based on the volume of oil flowing through their pipelines or other infrastructure, and as oil prices fell, many producers cut back. Result: less business and lower fees. Many MLPs are dependent on bond or even bank financing, so they’re also vulnerable to a rise in interest rates.
Moreover, as money flowed into MLPs during the boomlet, their prices rose (reducing their yields to Johnny-come-lately investors lured by the story) and Wall Street helped oil companies spin off their own MLPs, which weren’t always as great as the originals. MLP IPOs raised a record $6.8 billion last year, the Wall Street Journal reported.
In February, Sandusky wrote on her blog about one MLP formed in 2014. Antero Midstream was spun off by the oil and gas exploration and production company Antero Resources (ticker: AR). Midstream’s November IPO raised $1.1 billion, most of which went to the parent, which provided it with most of its business. But Antero Midstream has been valued by the stock market at roughly four times as much as its parent, based on its EBITDA (earnings before interest, tax, depreciation and amortization).
It certainly looks as though Antero Resources reaped the benefit of an act of financial engineering. "It’s easy to see why AR and others would take this route,” Sandusky wrote. Antero Midstream is down roughly 20% since its IPO. (Though Antero Resources has done even worse.)
Some investment analysts who watched the MLP meltdown unfold are now turning bullish on the sector. The stronger MLPs might do well even if interest rates rise, and if prices are now bottoming out, MLPs could be a great buy.
Or not. The lesson is to beware story stocks, because the story often is accurate only right up to the point that it’s not accurate any more. That’s when the crash comes. Let’s give Brown the last word. Even if you conclude that MLPs belong in your diversified portfolio, “Just go in with eyes wide open and an ear for the kind of myth-making that ascribes supernatural qualities to an asset class that hasn’t lived up to them thus far."