Here’s what they are and why they might deserve a place in your portfolio.
Master Limited partnerships, or MLPs, don’t have much to do with the tax-shelter limited partnerships of old, although they do share part of their name.
Capitalizing on the growing need to move energy products
These new MLPs are energy infrastructure investments that earn a majority of their income from the transportation and storage of energy commodities.
The reemergence of the U.S. as a major oil and natural gas producer has generated new interest in MLPs, as it spotlights the need for a better energy infrastructure to move, store and process energy.
“Most of the large crude oil and natural gas interstate pipelines still in use today were built around World War II,” say managers of an exchange traded fund that tracks the main MLP index.
MLPs build and operate pipelines and other transportation facilities (like rail terminal facilities) to move oil and gas from where it is produced to where it is needed.
Investing in MLPs
MLPs trade daily on the major exchanges, and are often conveniently packaged in exchange traded funds (ETFs) which makes them easier to invest in.
MLPs have several attractive features.
- High yield: The average MLP pays out an annual yield well above 5%, which makes them interesting to investors needing higher income.
- Tax advantages: MLPs have special beneficial tax structures, and are taxed as partnerships, not corporations, which means they can pass through income to investors without paying an extra layer of taxes.
- Inflation hedge: Investors gain exposure to inflation-resistant “real assets ” in the U.S. oil and gas industry, plus receive income payouts which may increase over time, helping investors to combat inflation.
- Diversification: MLPs don’t always track the major investment indexes, providing investors with some “yin” when the market “yangs.”
- Total returns: While MLPs, like all investments, have had good years and bad years, they’ve usually added an extra kick to portfolio returns. According to Jeffrey R. Kosnett in Kiplinger’s Personal Finance, “energy-related master limited partnerships have been remarkably consistent performers. They outpaced Standard & Poor’s 500-stock index every year from 2000 through 2011.”
At the same time, there are disadvantages to MLPs:
- Tax complexity: Depending on what MLPs you buy, and what account you buy them in, you can lose some of their tax advantages and create additional tax complexity.
- Illiquidity: MLP markets are not as deep and liquid as traditional stock and bond exchanges, meaning MLP markets can be more easily disrupted during times of market turbulence, and harder to negotiate due to price volatility.
- Concentration: MLPs operate in a relatively small market niche that could be disturbed by changes in tax or energy policy, or energy pricing. That’s why MLPs should be no more than a small piece of your portfolio, and not a major holding.