Benefits of investing in Master Limited Partnerships (MLPs)
In recent years a number of U.S. energy firms have reorganized their stable, slow-growing businesses, such as pipelines and storage terminals, into master limited partnerships (MLPs). This change in operating structure provides opportunities for investors to benefit from attractive and predictable tax-deferred income without the volatility of purchasing shares of individual securities.
Companies that use the MLP format tend to operate in very stable, slow-growing industries, such as pipelines. These types of firms usually offer unit price appreciation. However, the stability of the industries that use an MLP structure typically translates into below-average risk for investors. What’s more, cash distributions are generally relatively steady over time (growing at little more than overall inflation), causing MLP units to trade somewhat like bonds, rising when interest rates fall and vice versa.
When purchasing into an MLP, investors buy units of the partnership, rather than shares of stock, and are referred to as “unit holders.” There are two classes of MLP owner: general partners and limited partners.
- General partners manage the day-to-day operations of the partnership. An MLP technically has no employees, so all services, from management to bookkeeping, are provided by the general partners.
- All other investors are limited partners and have no involvement in the partnership’s operations. While the general partner stake is often 2% of the partnership, general partners can also own limited-partner units to increase their percentage of ownership.
Here are some benefits provided by investing in MLPs
- High yield. Most MLPs offer very attractive yields.
- Consistent distributions over time. Businesses operating as MLPs tend to be very stable and produce consistent cash flows year after year, making the cash distributions on MLP units very predictable.
- Deferred (and sometimes lower) capital gains. Firms primarily switch to the MLP structure to avoid taxes. While shareholders in a corporation face double taxation—paying taxes first at the corporate level, and then at the personal level when those earnings are received as dividends—owners of a partnership are taxed only once: when they receive distributions.
There is no partnership equivalent of corporate income tax. Cash distributions to owners often exceed partnership income, and when they do, the difference is counted as a return of capital to the limited partner and taxed at the capital gains rate when the unit holder sells.
Not only are capital gains deferred until an owner decides to sell, but capital gains tax rates are lower than income tax rates. In fact, many are particularly fond of pipeline MLPs, which have ample growth opportunities thanks to shifting sources of supplies of crude oil and natural gas.
However, unlike other energy companies, MLPs tend not to take on commodity exposures, reducing risk and cash flow volatility. With attractive distribution yield and offering the opportunity for capital gains, MLPs provide a compelling total return to investors.
- Lower cost of capital. The absence of taxes at the company level gives MLPs a lower cost of capital than is typically available to corporations, allowing the MLPs to pursue projects that might not be feasible for a taxable entity.
- General partner compensation aligned with limited partners’ interest. Most general partners are paid on a sliding scale, receiving a greater share of each dollar of cash flow as the limited partners’ cash distributions rise, giving the general partner an incentive to increase limited-partner distributions.
The Strategic Pipeline Income Fund as a MLP
The Strategic Pipeline Income Fund invests in landowner royalties, in addition to other energy infrastructure areas, in the rapidly growing areas of the Bakken Shale, Permian Basin, and Eagle Ford Shale. The fund has purchase agreements with exclusive pipeline brokers who provide steady royalties from leading suppliers.
If you’re an accredited investor seeking an attractive tax-advantaged dividend yield along with a diversification play for your portfolio, then download our Investment Summary to learn about the fund.