Ongoing fear of higher interest rates resulting from tapering by the Federal Reserve, whereby our central bank would wind down its policy of aggressive bond purchases, has served as a major drag on certain market sectors over the past few weeks.
One sector being hit particularly hard on the possibility of higher interest rates in the near future is the energy sector, and more specifically, oil and gas Master Limited Partnerships. MLPs, as they are more commonly referred to, enjoy a favorable tax treatment in exchange for paying out the vast majority of their profits as distributions to unitholders. As a result, MLPs have historically been among the market’s higher-yielding securities.
In that sense, MLPs are presently suffering right alongside bonds, as investors appear willing to ditch anything with yield. But investors are missing a key point that separates the two asset classes, and that tells me investors are missing out on a compelling buying opportunity.
Two industry stalwarts
Kinder Morgan Energy Partners LP (NYSE:KMP) is a $32 billion oil and gas MLP, and operates 75,000 miles of pipelines and 180 terminals. The company’s pipelines transport products including natural gas, refined petroleum products, and crude oil.
Kinder Morgan Energy Partners LP (NYSE:KMP) units have declined 10% just since April 23.
Similarly, Linn Energy LLC (NASDAQ:LINE) engages in the acquisition and development of oil and natural gas. As of the beginning of 2013, it had proven reserves of nearly 5,000 billion cubic feet equivalent of oil, natural gas, and natural gas liquids, and operated nearly 16,000 wells.
An interesting way to gain access to Linn Energy LLC (NASDAQ:LINE)’s hefty payout without the hassles of the K-1 is via LinnCo LLC (NASDAQ:LNCO), which is essentially a holding company for Linn and has the same $3.08 payout as Linn Energy LLC (NASDAQ:LINE) units.
Both Kinder Morgan Energy Partners LP (NYSE:KMP) and Linn Energy LLC (NASDAQ:LINE) are high-yielders that are seeing their units decline along with fixed income securities. Kinder Morgan Energy Partners LP (NYSE:KMP) now yields 6.20%, LinnCo LLC (NASDAQ:LNCO) pays 8.30% and Linn Energy surpasses them both with a 9.30% yield at recent prices.
The key point: Stocks are not bonds
As the saying goes, all things must come to an end. The Federal Reserve’s long-held policy of low interest rates and aggressive bond buying, while certainly a major contributor to rising asset prices since the Great Recession, cannot last forever.
That’s a good thing, bear in mind, because the Fed has maintained it would only taper off its bond purchases if it believed the economy could finally stand on its own legs.
And remember, investors, that MLPs are not bonds. Stocks, including MLPs, are pass-through securities that will handle higher interest rates much better than bonds.