Alerian MLP Index Suffered a Jolt Last Week

| About: Enbridge Energy (EEP)
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Last week was one the worst weeks for MLPs since the the market collapsed over 1½ years ago. Contributing to the selling was an article at the start of the week about risks associated with MLPs. The Alerian MLP Index (AMZ) dropped 11 to 322. In the first 4 days the index fell 17 (5%) but the rally on Friday limited damage. The index fell from its 2010 highs which were close to the 342 record set in July 2007. MLPs have been known as low beta (relatively small daily price swings) securities which has changed in the last 2 years. In July and August there were 31 trading days. On 9 days, the price swings exceeded 1% and on 2 additional days it exceeded 2%. Just last week had 3 days with over 1% changes and one more with a 2%% change. That's not low beta and these larger price swings are negatives which have not been priced into MLP valuations.

MLPs also have business risks. 2 weeks ago Enbridge Energy (NYSE:EEP), a leading MLP, had an oil spill in its Michigan pipeline which was built in 1969. Oil went into the Kalamazoo River and then Lake Michigan. Repairs containing the damages have gone well and the company kept the press informed. Last year, an EEP employee was killed in a work accident. The lesson is that MLPs are companies subject to problems. But so far none have been major.

Yields for the index are sharply lower in recent years. Between 1996 (its first year) and 2003, yields for the index were largely in the 7½-8½% range (and higher) as the index doubled to 200. Since then the yields have fallen to the 6½-7½% range (aside from double digits during the financial meltdown). Popularity of MLPs has grown substantially in recent years and investors have been willing to accept lower yields, currently 6¾%. With the recent decline in Treasury yields, demand has increased for higher yielding securities driving their yields to modest levels.

When the Alerian Index reached its record, its comparable index, including reinvested income, was 750. Today it's 891, almost a 20% gain - an amazing performance that few stocks can make (with reinvested income). More funds investing in MLPs brings new investors who have not been tested in rough times. In addition, fund managers invested heavily in MLPs can be fickle when under selling pressure. After enormous gains in less than 2 years, last week is a reminder about the risks of a pullback for MLPs. However high current income with a tax advantage, at a time when low yields are common, can be a source of comfort for MLP holders.

Disclosure: No positions