More Thoughts on Brexit; AMLP Reaches a Milestone

The Brexit vote is now two weeks behind us and I still watch developments with jaw agape. Rarely in history has the consequence of a popular vote led so directly to a recession. The IMF has forecast that the UK economy will shrink by 1.5% through 2019 if they agree to a Norway-style EU access (i.e. similar EU budget obligations, lack of immigration controls and submission to EU regulations but with no ability to influence them, not exactly what Brexiteers voted for). Or, if EU access conforms to the World Trade Organization (WTO) tariff framework, the UK economy will shrink by 4.5%. Leading Brexit campaigners such as Boris Johnson and Nigel Farage have exited stage left now that their goals have been achieved. Brexit voters gamely advise that everything will be OK, while decision makers prepare for a recession. Fewer UK jobs will likely reduce immigration anyway, although this is hardly the best means of achieving that goal. And yet, in theory the entire non-UK EU population of almost 450 million people could have relocated to the UK, at which point the country would have resembled a Piccadilly line tube train at 5pm. Free movement of people, a core, inviolable principle of the EU, is absurd.

Nonetheless, Brexit was not a carefully considered response but a visceral reaction with far-reaching and poorly considered consequences. Churchill  once said, “The best argument against democracy is a five-minute conversation with the average voter.” Brexit leaders have led their followers to the cliff and then retired to the pub for a drink while they watch the leaderless deal with the aftermath.

One result is that bond yields globally have fallen to hitherto unimaginable levels. The Barclays Aggregate Index is +6% YTD, beating the S&P500. Regular readers will be familiar with our past illustration of the paltry returns available on bonds whereby we compare a barbell of stocks and cash with the ten year return on bonds. In our April newsletter we wrote about The MLP Risk Premium. With reasonable assumptions about MLP distribution growth rates and prevailing valuations in ten years, you could swap out your bond portfolio for as little as 10% in MLPs with the rest in cash while still achieving a bond-like return. MLP yields have fallen since we wrote that in April, but so have bond yields so the broad set of choices still favors almost anything over bonds but certainly still MLPs.

Federal Open Market Committee (FOMC) minutes released last week confirmed what we’ve long noted, that Janet Yellen will never miss an opportunity to avoid raising rates. Ignore their words and try considering this Fed’s actions as if they’d announced the solution to excessive debt was to keep rates low for a long time. The rhetoric doesn’t reflect such a strategy but their actions most assuredly do. Waiting for rates high enough to justify an investment requires substantial patience, during which time investors are steadily pursuing equity-type risk with its better return prospects.

Tallgrass Energy GP (TEGP) raised its quarterly distribution by 16.7% quarter-on-quarter and 84.2% year-on-year from its pro-forma 2Q15 level. Not every MLP or GP is raising its distribution by any means, but less than six months ago such would have been unthinkable. Meanwhile, the Alerian MLP ETF (AMLP) reached a milestone of sorts, in that the recent recovery in MLPs has finally moved AMLP to where it once again has unrealized gains on its portfolio. As we noted in March (see Are You in the Wrong MLP Fund?) this is the point from which AMLP investors will now earn only 65% of any subsequent upside since the U.S. Treasury will take 35% through corporate tax. Indeed, the tax drag has already had an effect, since AMLP’s YTD performance through June 30 is +10.7% versus the Alerian Infrastructure Index +13.1%. Those AMLP investors who are bullish on the sector (which presumably includes all of them) will, if right, contribute modestly to Federal finances at the expense of their own investment results and reputation for careful analysis. AMLP is the refuge of those who stop at Pg 1 of a prospectus rather than examining Pg 23, Federal Income Taxation of the Fund. This is part of the reason why a more thoughtfully designed, non-taxable, RIC-compliant MLP fund (which we run) has done very well.

We are invested in TEGP.

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