Master Limited Partnership Yield

The Search for Yield

In today’s low-yield environment, it has been difficult for investors to find investments that offer income.  For many portfolios, generating income is a major component of the strategy.  Yield refers to the income return on an investment.  Yield is a function of the investment’s income (dividend, distribution, income, interest rate) and the price of the investment.  For bonds, the current yield is expressed by annual interest rate/current price of the bond.  So if the bond is trading at par at $100 and pays a 5% coupon then the current yield is 5%.  If that bond was trading at $90 though, so 10% under par value of $100, then that same 5% coupon would make for a current yield of 16.67%.

Central banks have been keeping interest rates at record-lows in recent years.  Investors around the globe have flocked to the safety of bonds, pushing prices for treasury bonds and other safe-haven securities up.  That combination has kept yields down for many investors as the price of bonds has stayed high and interest rates for bondholders haven’t ticked up.

Master Limited Partnership “Yield”

Analysts and investors often point to relatively high yields offered by master limited partnerships as a main reason to invest.  As we’ve discussed elsewhere on this site, master limited partnerships distribute income to unit holders on a quarterly basis (though as you’ll read below, that’s not guaranteed).  These distributions are typically treated as a tax deferred return of capital, which helps lower the unit holder’s tax basis.

Yield can be calculated on a current or forward basis.  Current yield is calculated by dividing the current declared quarterly distribution annualized by the current unit price of the MLP.  Forward yield is calculated by taking the master limited partnership’s estimated next 4 quarterly distributions and dividing that by the MLP’s current unit price.

With typically high distributions, master limited partnerships can offer considerable yield to investors and that has attracted some in today’s low-yield investing environment.

Master Limited Partnership Yields Today

Whereas investors are buying up bonds and keeping prices high, master limited partnerships (another traditional source of income and yield) have seen their prices fall significantly in line with the collapse in oil prices over the last two years.  Since MLPs are publicly traded, the price of these investments has fallen significantly as the world digests a glut of oil and investors appear to be tying MLPs to the fortunes of oil (though that link is debatable, as many industry experts have noted).  The depressed price of master limited partnerships has had the effect of potentially increasing yields for these investments relative to prices.

The usual caveats apply of course, not all MLPs are the same and distributions are not guaranteed.  That last point is critical, as some investors have mistakenly viewed master limited partnerships as equal to bonds in providing a fixed income through their distributions the way that bonds do through the coupon.  As we’ve noted, MLPs aren’t bonds and it’s important to understand that.  For more on this topic be sure to read Master Limited Partnerships are Not Bonds.

We won’t focus on today’s market, as this is an educational website aimed to improve your general understanding of master limited partnerships and how these firms operate, but we’ve seen a lot of market commentary recently about how MLP yields are standing out in today’s low-yield environment.   Hopefully you have a better understanding of yield now and yields of master limited partnerships.

 

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