Though MLPs have on the whole produced positive returns historically during periods of lower commodity prices and rising interest rates, year-to-date the Alerian MLP Index (AMZ) declined 17% on a price-return basis as of July 17. In contrast, the S&P 500 gained about 3% for the year. At the same time, distribution growth has increased year-over-year (YOY) in eight of 10 Yorkville MLP Indices, with only the natural resource index and E&P index cutting YOY distributions.

What is driving MLP underperformance in 2015? Most tend to point to a correlation of MLPs to other energy stocks and, in relation, commodity prices. However, according to a research note from analysts at Raymond James & Associates Inc., “We believe underperformance of this magnitude has to be explained by multiple drivers.”

Though investors have been concerned primarily with low crude, gas and NGL prices negatively affecting MLP performance, “analysis shows that crude oil prices do not solely drive returns across the midstream space,” the Raymond James note said. Rather, historical MLP performance has tracked closely with high-yield bonds.

Raymond James examined the correlation between the AMZ and a portfolio of high-yield bonds over both a one-year and five-year period and found a significant correlation, indicating that investors likely view MLPs and high-yield bonds as similar investment vehicles, with similar risks and returns.

“As such, our supposition is that high-yield bonds (and, by inference, MLPs) trade more like equities than investment grade, fixed income securities but also capture the sweeping impact of rising interest rates,” the Raymond James note said.

The relation between MLPs and high-yield bonds lead to concerns about rising interest rates leading to higher costs of capital, a higher discount rate on equity capital and a financial impact on entities with floating-rate debt.

“However, the combined impact of these factors is difficult to quantify and several MLPs have taken advantage of the accommodative, long-lasting, low-rate environment (~$28 billion in debt financing in 2014, including 30-year bonds issued at nominal rates as low as ~5%),” the note said. “While we expect to eventually see a rising interest rate environment negatively impact MLPs, we believe the incremental impact is at least partially ‘baked in’ to the risk vs. reward at current valuations.”

According to July’s “Yorkville MLP Beat” from Yorkville Capital Management LLC, the view that rising interest rates negatively impact MLPs is widely held, but not necessarily supported by historical performance.

“MLPs produced positive returns across entire interest rate cycles, whether it was the 10-year or three-month U.S. treasury (UST) yields that were rising,” the note said. “In five out of six rising rate environments (10-year UST), MLPs produced positive returns averaging 18%,” while “during Fed tightening cycles, MLPs produced an average positive return of 9%.”

MLP returns increased overall during historical interest rate increases, but each period of rising interest rates began with short periods of negative returns, Yorkville’s note added.

This trend “appears to be more than a coincidence, occurring in five of six rising interest rate environments,” the Yorkville note said. “On average, MLPs initially pulled back 21 trading days into the cycle, these pullbacks lasted approximately 27 trading days, and MLPs averaged a decline of -8.9% during these periods.”

Despite the current investor uncertainty, it is unlikely MLPs will continue to trade at their current low levels for long.

“We remain confident that over the medium-term (i.e., 12+months out), MLPs will trade considerably higher than current levels as both organic and inorganic growth in the midstream/MLP sector drives investors to allocate capital to the companies/partnerships with the most visible pathway to creating long-term value,” the Raymond James note added.

The September issue of Midstream Business will feature a more detailed analysis and outlook for midstream MLP performance.