While master limited partnerships have attracted investor interest for decades, recent changes in the ways investors can access these vehicles and a low-rate environment have lead to more interest in this evolving sector. Investors can now access MLPs through publicly-traded and privately-held vehicles at a time when more types of assets are being packaged under the MLP label than ever before.

In order to qualify as an MLP, a company must receive at least 90 per cent of its income from real estate rents, interest, dividends or gains from the sale or income of commodities, commodity futures, mineral or natural resources activities. MLPs offer investors tax advantages, in that they avoid taxation at the corporate level by passing on virtually all income and gains to their investors, who serve as limited partners. Most MLPs are found in the energy industry, where MLPs specializing in oil and gas industry infrastructure abound.

“Many MLPs are the owners and operators of energy infrastructure,” says Libby Toudouze, a partner and portfolio manager with Swank Capital, an asset manager specializing in MLPs located in Dallas, TX. “We describe these assets as toll road assets – pipelines and storage facilities. They are really basic and boring assets. The MLPs don’t take ownership of the commodities that are transported, but provide a critical component of the energy supply chain.”

Advantages

MLPs offer certain advantages. Toudouze believes one major pro is their ability to deliver a steady yield of 5 to 7 per cent – a bonanza in an extremely low-rate environment. “Where else can you get an equivalent yield without the risk?” she asks. “High-yield bonds are more risky and you can’t find this type of yield in dividend stocks or higher quality bonds.”

One reason the after-tax income is so lucrative from MLPs in the energy sector is because the tax code allows MLPs to depreciate their assets over the life of those assets, according to Drew Kanaly, CEO of Kanaly Wealth Management in Houston, TX. “So you can depreciate the asset and it tends to offset your rents, producing a lot of very good after-tax income,” he adds.

Alan McKnight, partner and director, global investment strategy at Balentine Investments in Atlanta, GA, believes the need from the developed and developing world for energy infrastructure is not dependent on the price or availability of energy itself, and will continue to drive the success of MLPs that invest in energy infrastructure. “We have an allocation to these in client portfolios now,” he says. “They’ve done extremely well, and while you don’t want to chase performance, the world is going to need more infrastructure for energy products because no one is slowing their consumption of these assets.”

Diversification is another key selling point of MLPs, Kanaly says. “They are a good asset to invest in and we like them in the alternative category because they tend not to look like or perform like stocks and bonds, although they can exhibit risk characteristics of both of these asset classes,” he continues.

Disadvantages

For investors, investing in an MLP can make taxes complicated. Owners of partnership shares receive K-1 forms from the partnership and must file a separate form with their personal taxes and pay taxes on any gains from the MLP, according to Kanaly.

In addition, environmental concerns can be a problem for MLPs looking to build or acquire new infrastructure assets, he says. “There are environmental concerns, to be sure,” he says. “Pipelines do occasionally rupture, but it’s not anything that the pipeline operators want to have happen. They lose money every day that the oil or gas isn’t flowing. There can be problems with negative publicity.

“And with a brutal regulatory environment in terms of environmental laws, it can be very difficult to get new projects approved,” he continues. “The problem there is that you make it harder on the industry to deliver the energy that we need, which sows the seeds of higher energy prices.”

Evaluating MLPs

When it comes to evaluating MLPs, Kanaly asks these questions:

·        What is the MLP’s asset base?

·        What are their rents?

·        How solid is their ability to rent their assets out?

·        Where are the MLP’s assets in their usable asset life?

·        Where are they in the reinvention cycle – how will they grow the business when their current assets wear out?

“It takes a bit of digging to ferret out this information, but its not that hard,” he continues. “If you look at this type of infrastructure worldwide, we tend to be pretty infrastructure poor. Here in the US, construction of liquefied natural gas terminals should be a big deal because we are going to be producing more gas than we can consume here, so we ought to sell it. We need to export it, but it takes a lot of work and planning to get the terminals put into place.”

New investing structures

One recent development that is useful for wealth managers is the availability of a variety of ways to invest in energy infrastructure outside of MLPs, says Toudouze. “You can invest in publicly-traded stocks that own partnerships and open- and closed-end mutual funds,” she notes.

Expenses for open-ended funds that invest in this space are pretty reasonable, she says. They are higher for closed-end funds. Within the open-end fund and ETF space, there are actively managed mutual funds, index funds and exchange traded funds and exchanged traded notes.

“If your client has less than $500,000 to invest, it makes sense to go with a fund or ETF structure,” she says. Toudouze expects the universe of investing options to continue to evolve for energy infrastructure investing. “It’s where real estate investment trusts were 35 years ago – there is a lot of potential for the industry today and in the future.”