MLPs – An Early Christmas Present by Evergreen Gavekal

“It is madness to risk losing what you need in pursuing what you simply desire.” – Warren Buffett

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  • Almost all investors today are in need of better valuations to support their long-term return prospects and/or better cash flow to fund their ongoing spending needs.
  • The problem is that almost everything has been overvalued for the past several years. This “purgatory of low returns” left investors with a limited list of uncomfortable options: (1) reach for ever-shrinking yield, (2) chase capital gains in overvalued markets, or (3) sit in cash.
  • But with credit spreads blowing out and oil prices collapsing over the past year, the markets are giving us an early Christmas present: deeply discounted midstream Master Limited Partnerships (MLPs).
  • MLPs have not necessarily bottomed, but we believe they will benefit from a faster-than-expected recovery in the energy markets over the course of the next few years. And with yields currently in the high single-digits, we believe investors are being well compensated to look through the cycle and wait patiently for a recovery.
  • By making it more palatable to hold large cash reserves and to stay defensive across our client portfolios, the combined value and yield opportunity in high quality midstream MLPs is helping us to (1) create enough cash flow for our clients to live on while (2) protecting their portfolios against the upcoming bear market in US equities.
  • The markets have seen fit to let us unwrap one present, but we still have to wait patiently through the night for “Christmas morning” when investors can rotate back into stocks at fire sale prices.


By Worth Wray, Chief Economist

Does your family have any Christmas traditions? Mine certainly does.

On Christmas Eves growing up in South Louisiana, my family would always come home from church late in the afternoon, cook a holiday feast together, and gather around the fire to read the Cajun Night Before Christmas. (Yes, where I come from, Saint Nick rides a skiff pulled by eight flying alligators.)

MLPs - An Early Christmas Present

Then and only then, my three siblings and I each got to unwrap one present before bedtime… although the decision was not always up to us. Some years, my parents would let us choose any package wrapped under the tree. Other years, they would have a specific one in mind.

As you can imagine, opening just one was often agonizing for a child who had not yet learned the value of delayed gratification and had been staring at a tree full of gifts for weeks on end. By the time Christmas Eve rolled around, I usually felt like I had been patient long enough and so those last 8 hours between bedtime and Christmas morning were the hardest.

I can remember laying awake at 3:00 AM on more than one occasion, torn between the greed of sneaking a peek at what Santa had delivered and the fear of losing what could be mine if I could just wait a few hours longer. For a little boy who believed in Christmas magic longer than most of my peers, I didn’t want to be the kid who makes it onto Santa’s naughty list at the last minute and then wakes up to find a stocking full of coal.

And so I waited – sometimes all night – for morning to come… for presents, and stockings, and hot chocolate by the fire… for Cajun eggs benedict and hours of laughter… for enough magic to last through the year. Those mornings were always worth the wait.

Now that I am married and in my thirties with bills, responsibilities, and a life of my own, I could not be more grateful for Christmas mornings on the bayou.

Oddly enough, the whole experience prepared me for the emotional roller coaster of investing by teaching me to accept what the market gives me, helping me to learn the rewards of patience, and forcing me to weigh the potential cost of impatience.

Those are important lessons for investors today, especially considering the drama we’ve all lived through in recent years. In a world of ultra-low interest rates and almost universally overvalued markets, value became almost impossible to find after markets recovered their losses from the global financial crisis. In July 2013, GMO’s James Montier described this period as “the cruelest time to be an asset allocator” arguing that everything had become expensive from equities and credit to commodities and US Treasuries.

What’s more, yield was nowhere to be found. The universe of fixed income assets yielding over 4% shrunk by more than 75% after the Fed dropped interest rates to zero in 2008 (figure 1). The whole concept of relying on livable cash flows from low-volatility investments like US Treasuries, munis, and investment grade bonds went out the window just as the Baby Boomers (the generation born between 1943 and 1960) started to reach retirement age (figure 2).


As recently as early 2014, this “purgatory of low returns” left investors with a limited list of uncomfortable options:

(1) We could reach for ever-shrinking yield to fund our spending needs, which meant taking on substantially more risk in less familiar and often less liquid asset classes like junk bonds, Master Limited Partnerships (MLPs), or emerging market debt.

(2) We could chase capital gains in overvalued asset classes like US stocks, feeling wealthier while effectively locking-in disappointing long-term returns and/or setting ourselves up to make emotional mistakes in a correction.

(3) Or we could sit in cash, avoiding market losses while steadily losing purchasing power to inflation and personal spending. While this is clearly the most prudent option in the face of overvalued, overextended markets, sticking to a value discipline in the face of rising markets can take a heavy psychological toll as the market screams higher.

Fortunately, times are changing.

With credit spreads* blowing out (figure 3, next page) and oil prices collapsing (figure 4, gray line) over the past year, the markets are giving yield-starved retirees, cash-heavy contrarians, and reformed performance-chasers an early Christmas present: deeply discounted Master Limited Partnerships (figure 4, green line).

*The difference between corporate bond yields and US Treasuries of comparable maturities


Let me be clear, I’m not saying the MLP asset class has necessarily reached its bottom; but it’s a whole lot closer than the richly-valued S&P 500, which continues to trade near all-time highs (figure 4, white line) despite falling profit margins (figure 5) and a higher median price/sales ratio than the market peaks in both 2000 and 2007 (figure 6).


As you can see in the chart on the next page, the Alerian MLP Index has fallen roughly in line with the 2007-2008 crash and continues to trade at extremely depressed levels as a result of falling energy prices and rising high yield spreads.



Source: Evergreen GaveKal,

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