The MLP Yuletide Spirit
This time of year usually prompts a blog post on MLP seasonals. It’s been a reliable topic (see 2015’s Why MLPs Make a Great Christmas Present or 2016’s Give Your Loved One an MLP This Holiday Season). The Alerian MLP Infrastructure Index (AMZI), which is tracked by the Alerian MLP ETF (AMLP) has long displayed a pronounced January effect. Individual investors tend to assess their portfolios around the calendar year end, but the K1s accentuate this effect for MLPs.
If you’re considering selling an MLP, doing so in December instead of January avoids an extra K1 for the stub year. Similarly, a purchase delayed from December to January avoids a one month K1 from the prior year. Using AMZIX data since 1996, the January effect is clearly visible.
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The Covid pandemic distorted the pattern somewhat. In March 2020 the AMZIX collapsed, closing the month –48%. It was a miserable time to be invested in the sector. The following month’s rebound was +48%, although that still left the index –34% YTD. Some excessively leveraged operators were partly to blame (see MLP Closed End Funds – Masters Of Value Destruction).
These two months dominate the average March and April returns, rendering the other months seemingly inconsequential.
Five years ago it looked as if the seasonal pattern was weakening (see MLPs Lose That Christmas Spirit) but in hindsight we were just looking back on a period of poor performance during which almost every month was flat or down.
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Seasonals are now back in vogue. Sell-side research routinely mentions the January effect. Morgan Stanley noted that year-end, “historically has pointed to positive performance capture in late December through January.” A strategy of going long at the end of November for two months has an average return of +2.9%, roughly a third of the annual return. Morgan Stanley found that since 1996 MLPs have “posted a positive total return from December 15 through the substantive balance of January,” constituting 41% of the total return during that time.
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It has been possible to earn much of the sector’s return with comparatively short holding periods arranged around year’s end.
The effect is less pronounced for the American Energy Independence Index (AEITR), probably because it limits MLPs to 20% so as to be investable in a fund without being taxed as a corporation. Institutions are much less likely to be driven by the calendar, not least because their investment returns are mostly not taxed. The S&P500 exhibits no meaningful seasonal pattern.
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Less appreciated is the quarterly pattern around payouts. MLP investors love their distributions, which are generally paid in the first month of the quarter. Because of the distortion caused by Covid in 2020, it’s helpful to look at median returns rather than average. Over the past five and ten years this quarterly pattern is generally visible. For the past decade January was positive seven times and April eight. Oddly, July doesn’t show any seasonality.
Even with the median return, April still stands out as an appealing month. Perhaps a few investors annoyed at the delayed tax filing often caused by K1s decide to sell just as soon as they receive their April distribution. This was even true during the 2013-18 period when no other seasonal pattern was visible. I’ve personally found April to be the most interesting time to make seasonal trades in this sector.
Few MLP investors will find trading their positions appealing. The point of MLPs is to enjoy those tax deferred distributions for as long as possible, putting off indefinitely the recapture of taxes generated by a sale. These holders wouldn’t be interested in the possibility of a quick buck at the risk of an accelerated tax obligation.
In the spirit of open-mindedness and in spite of its numerous shortcomings routinely described on this blog, I can suggest AMLP as a temporary trading vehicle for this purpose. Since it is 100% MLPs it reflects the same seasonal pattern as its index, AMZI. In the past I have found it preferable to use options on AMLP rather than buying or selling the ETF directly. I already have plenty of exposure to the sector, so concluded that for a trade seeking to pick up a few per cent it’s imprudent to add any more long exposure.
In Sunday’s blog I incorrectly said Vettafi, who publishes AMZI, had dropped the 12.5% position limits in their quarterly rebalancing and allowed Energy Transfer to remain at 19.5%, a level it reached both through appreciation and the acquisition of Crestwood. It turns out they were just slow to update their website. TMX Group announced their acquisition of Vettafi last week. Perhaps they were distracted.
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We have three have funds that seek to profit from this environment: