Master Limited Partnerships are distributing income of almost 7% per year to investors at a time when short-term bonds are paying close to zero, which makes them an enticing option for retirees.
“MLPs Become Enticing Option for Retiree Investors”
—Title of a recent Bloomberg news segment
Bloomberg carries credibility, so viewers listen, and their takeaway is likely positive regarding the above quote from a Bloomberg news segment. After all, Master Limited Partnerships* (MLPs) are distributing income of almost 7% per year to investors at a time when short-term bonds are paying close to zero. MLPs are able do this because they invest in infrastructure that generates revenue, including pipelines for crude oil, natural gas, and other energy products.
This happy scenario makes MLP Investors dance with joy. Others notice and are jumping on the bandwagon. This is reflected in the proliferation of mutual and exchange-traded funds entering the MLP market. Last year, $12 billion of new money was invested in MLPs with roughly 66% coming from individual investors. This means the market is huge.
There are multiple beneficiaries from MLP’s:
• The general partners who manage the entity and take a percentage of the profit.
• The investors who receive a rich yield (about 90% of the profit must be returned to investors).
• And, lastly banks from which MLP’s borrow money. Since MLP’s distribute the major part of their earnings to investors, the only way they can grow is to borrow.
The stimulus behind this fairyland scenario is the recent US energy boom, which may continue for some time. The International Energy Agency forecast that the US will be the world’s largest fuel producer by 2020, even surpassing Saudi Arabia. Pipeline MLPs play right into this scenario.
But, if the need for pipelines was to decline or revenues decreased for any reason, there would be a different story.
A vivid example is Boardwalk Pipeline Partners (BWP), which decreased payout to investors in February 2014, reportedly due to falling income from its pipelines. Then the BWP price per share dropped precipitously by nearly 50% (see below).
BWP is a single stock. A fund containing multiple stocks would be affected less adversely.
Another concern regarding MLPs is that they are difficult to understand. In spite of this, two-thirds of their investors are individuals, most of whom are unlikely to fully appreciate the risks. When and if the MLP market fails, it is likely the professional investors (the remaining one-third) who will be the first to know and exit quickly. This could leave individual investors in a fund or stock that is falling like a knife.
My caution for individual investors who own MLPs is that they watch carefully, especially around earnings announcements. In addition, a limit order to sell if they fall more than 5% or 10% might be considered. Another option is to sell prior to any bad news, but, sadly, the flush yield evaporates, too. Of course, traditionally funds carry less risk than any individual stock and this would be true of MLPs as well.
And, lastly, for those who don’t already own MLPs, it may be wise to consider such a purchase carefully.
*The Investopedia definition of Master Limited Partnership
A type of limited partnership that is publicly traded. There are two types of partners in this type of partnership: The limited partner is the person or group that provides the capital to the MLP and receives periodic income distributions from the MLP's cash flow, whereas the general partner is the party responsible for managing the MLP's affairs and receives compensation that is linked to the performance of the venture.
One of the most crucial criteria that must be met in order for a partnership to be legally classified as an MLP is that the partnership must derive most (~90%) of its cash flows from real estate, natural resources and commodities.
The advantage of an MLP is that it combines the tax benefits of a limited partnership (the partnership does not pay taxes from the profit - the money is only taxed when unit holders receive distributions) with the liquidity of a publicly traded company.
MLP interest growing: This information from Fidelity provides more information and is recommended for those invested in MLPs or those thinking about it.