In our previous article we looked at the construction and composition of the Alerian Size Indices. Today, we’re pitting the three indices against each other and directly comparing their performance. Will the large-cap MLPs roll over the competition with their large footprints and stability? Or will the volatile and nimble small-cap MLPs outmaneuver the field for a victory? To find out, let’s take a look at the value of $1,000 invested in each index over the past decade. This time period provides a comprehensive view, as it includes the 2008 great recession/ recovery, as well as the current commodity crisis. As a point of reference, the S&P 500’s performance is also included, along with the benchmark for the space, the Alerian MLP Index (AMZ). All of the data referenced in this piece is on a total-return basis.
The Alerian Large Cap MLP Index (AMLI) came away with a middling performance, even trailing during the boom years of the shale revolution. However, it did have the fewest peaks and troughs, implying a low relative volatility. On the flip side, the Alerian Small Cap MLP Index (AMSI) was all over the place, with excellent performance in good times, but also the steepest drop once the markets turned against them. Being smaller equities, it takes far less to move the needle, but the needle moves in both directions: they were the worst-performing index over the past 10 years and exhibited the highest volatility. The Alerian Mid Cap MLP Index (AMMI) came away with the best balance of stability and performance at the end of the day.
Below is a tabulated view of each index’s performance data.
The numbers corroborate with what we can intuitively see in the performance graph. The AMSI has the highest standard deviation (most volatility) out of all of the indices. On the other hand, the S&P 500, being composed of some of the largest and most liquid companies in the US, has less volatility than any of the MLP indices. Compared to the benchmark AMZ, over the 10-year period, the AMSI underperformed, the AMMI outperformed, while the AMLI followed the AMZ’s performance pretty closely. This makes perfect sense, as the 24 names in the AMLI represent roughly 70% of the total energy MLP market cap, while the AMZ (designed to be representative of the space as a whole), captures around 85%. When looking at the Sharpe Ratio, which is a measure of risk-adjusted return, mid- and large-cap MLPs look like a compelling investment, despite the recent turbulence in the energy sector.
Around 2005 to 2008, the yields of the three indices were relatively in-line; the spread between small- and large-cap MLPs were rarely more than 100 bps from each other. At this point, the market cap of the entire sector was around $100 billion and investors in the space were less discriminating. MLPs were all valued generically, with few investors rigorously researching the space. However, during the financial crisis, yields blew out, and it became obvious that the large-cap MLPs had the balance sheets to weather the storm while the small-cap MLPs faced more challenges. The AMSI’s yield peaked at around 23%, the AMMI’s hit 19%, while the AMLI’s rose to a high of 13%.
From 2010 and onwards, as the space grew, the yield gap between small-, mid-, and large-cap names grew as well. An increased interest in the asset class brought on a wave of MLP-focused investment products, which brought additional liquidity to the space. This increase in popularity also meant increased scrutiny, which further exacerbated the spread between small- and large-cap names. There was also an inherent bias towards large-cap names, as larger MLP access products favored the liquidity that they provided. As of December 31, 2015, the spread between the AMLI and AMMI was 218 bps, while the spread between the AMMI and AMSI was 410 bps.
In the end, if we all had crystal balls, we could all buy low and sell high and be rich. Unfortunately, that’s not the case. Individual investors need to decide for themselves what kind of risk/reward profile they’re able to stomach. In the realm of MLPs, we’ve shown that while small-cap MLPs may ramp up like a rocket when times are good, they also fall the most when times are lean. Large-cap names may have the least volatility, but with the lower risk also comes lower overall reward. Mid-cap MLPs may hit that sweet spot in terms of returns, but the overall Sharpe Ratio is still slightly behind the AMLI. If you’re on the prowl for yield, be wary of what you wish for. While the AMSI has consistently had a higher yield than its peers, it’s important to keep in mind that the high yield is there for a reason, and does not necessarily mean strong total returns in the long-run.
Whichever direction you go with your investments, we hope to leave you with enough data and analysis to make an informed decision. Good luck!