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Mastering the MLP Domain


MLPs have handily trounced both the Dow Jones Industrial Average and S&P 500 Index since the start of the millennium. But there's a hornet's nest of hidden costs the investor has to consider.

MINYANVILLE ORIGINAL It's the exceptionally rare person ever associated with Enron who emerges with their reputation intact, much less enhanced, but Richard Kinder has proved a profitable exception. As Kenneth Lay's college buddy, Kinder was the ill-fated firm's president for six years before leaving to found Kinder Morgan Energy Partners (KMP) in 1997. While other Enron alums including Jeffrey Skilling serve jail time, Kinder's company has served up annual returns of approximately 25%.

Mr. Kinder is considered a founding father of the master limited partnership (or MLP), an often obscure asset class that is attracting ever more investor attention. MLPs have handily trounced both the Dow Jones Industrial Average (^DJI) and S&P 500 Index (^GSPC) since the start of the millennium.

With the Fed committing last week to keeping interest rates at record low levels at least through mid-2015, the frantic search for yield shows no signs of abating. 10-year Treasuries (^AXTEN), while off their record low of 1.379% reached on July 25, remain utterly unenticing. In other countries, investors are being forced to pay for the dubious privilege of owning debt.

Master limited partnerships -- where yields of 6% are common and 8% not unheard of -- have hence become increasingly attractive in a rock-bottom rate environment where other options are so scarce. For those who believe demography is destiny, MLPs also have a generational tide on their side. 10,000 baby boomers become eligible for Social Security each day, and are increasingly risk averse as retirement nears. Having seen life savings evaporate in the Great Recession, they crave income opportunities, but are hardly about to jump headlong into junk bonds or speculative emerging market debt.

The defensive characteristics many MLPs offer, then, provide huge appeal in a period of ongoing market turmoil. Often hiding in plain sight, either unloved and misunderstood, MLPs have much to recommend them, but as we shall see there are downsides, too.

ABCs of MLPs

To qualify as an master limited partnership, the entity in question must derive a minimum of 90% of its income from sources deemed to be "qualifying" by the Internal Revenue Service. In practice, this entails activities related to the extraction, storage, and transportation of energy commodities, natural resources, minerals, or real estate.

An MLP comprises both general and limited partners, with the former a decision-making member of management, and the latter a passive investor that provide capital.
No positions in stocks mentioned.
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