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December 23, 2011

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MLP Performance Review: Is It Safe?

The MLP Index is on track to post a 2011 price change of around 5% and a total return of more than 10% (factoring in distributions).  It will mark another year of MLPs outperforming the S&P500, the 11th time in the last 12 years that has happened (2008 goes down as a tie, with both indexes down 37% on a total return basis).  That kind of repeated outperformance by the MLP Index is a result of the secular growth story behind the assets they own and the hunger for yield from an aging population (caused in some part by low rates).  But another major factor is the MLP structure and the high payout ratios of MLPs that force management teams to be prudent stewards of the capital they oversee.

It has not been smooth sailing for MLPs this year, however, and there were a few corrections and scares along the way that flushed out some of the weaker MLP holders, providing opportunities for long term holders.  The chart below shows the performance of the MLP Index with each of the 5 years plotted across one calendar year.  Looking at the 2011 line, there were periods during May and August, when it seemed the index was tracking 2008.  But the 13%+ rally this 4th quarter looks more like 2009 and 2010 than 2008.  However, also noteworthy is that the last time MLPs had a somewhat complacent year amidst a weak economic backdrop (2007), the following year turned out pretty pretty bad.

Also, the year to date MLP Index price change of around 5% is somewhat deceiving.  An equal weight average of the Alerian MLP Index members would have been up only 0.2% so far in 2011.  The 10 largest MLPs, which collectively account for 59.3% of the MLP Index, have gone up on average 9.4% so far in 2011, compared to -2.0% for the other 40 members of the benchmark Alerian MLP Index.  Large cap MLPs were the best performers this year.
All year, investors seemed to be struggling with the same question Laurence Olivier’s dentist asks Dustin Hoffman’s character repeatedly in the Marathon Man (video below, starting around 1 minute mark): Is is safe?  And it appears that many investors determined it wasn’t safe, and were not participants in the fourth quarter light volume melt-up.

Is it safe? Hoffman’s character doesn’t know the answer, and neither did anyone else this year.  Large, famous managers were confounded by the market this year, as outlined in this post by Josh Brown.  Some very famous players even folded up shop (like Soros).  For them and for the rest of us, much of the year we felt more like Hoffman’s character, tortured by daily swings up and down, numb to the pain of what seemed like an endless stream of disappointing  economic data-points.
In the end, the year turned out fine and it was safe, but many investors have given up on the market in the process, or they are waiting to time their entry for when things seem more “certain”.  That mountain of cash on the sidelines remains.  If history is any guide, when it finally appear “safe” for invstors to jump back in the markets, it will be just when the market is no longer safe.
Disclosure: The information in this article is not meant to be financial advice, we are not your financial advisor and I am posting my comments for informational purposes only. 

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