Understanding Master Limited Partnerships
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December 3, 2007
An investment vehicle that is often misunderstood but could indeed be valuable in the portfolio diversification process is the Master Limited Partnership, also commonly referred to as an MLP. An MLP is a limited partnership that is publicly traded on an exchange. Master Limited Partnerships are limited to only apply to enterprises that engage in certain businesses, mostly pertaining to the use of natural resources, such as petroleum and natural gas extraction and transportation. Some real estate ventures may also qualify as MLPs.
Today there are more than 50 actively traded MLPs, with a total market cap of nearly $80 billion and are popular because of the big dividends yields they provide the income seeking investor. Shares of MLP ownership are referred to as units. Unlike a corporation, a master limited partnership is considered to be the aggregate of its partners rather than a separate entity. This particular investment vehicle combines the tax advantages of a partnership with the liquidity of a publicly traded stock.
It is important to note that MLPs are not subject to corporate income tax. As a result, more cash is available for distributions than would be available had the companies incorporated. The popularity of MLPs of course is their terrific track record for raising dividends over that past ten years, which has certainly endeared them to income investors.
In practice, MLPs pay their investors through quarterly required distributions, the amount of which is stated in the contract between the limited partners (the investors) and the general partner (the managers). MLPs typically fall into four main groups: pipeline carriers, coal leaseholders, and oil and gas leaseholders.
Like Real Estate Investment Trusts or REITS, MLPs pay out most of their cash flow to shareholders. In addition, the average yield on an MLP is 6.4 percent versus the 1.7 percent average yield offered by the average stock in the S&P 500 Index.
Another important point is that most MLPs process and ship oil and gas, so it’s only natural to think they would be impacted by commodity prices. However in reality their cash flows depend primarily on product volumes, not commodity prices. As a result, they offer some of the most stable distributions around. This rare mix of both safety and growth make MLPs a very desirable asset class in a diversified portfolio.
Jeff Neal
Senior Writer, Options Strategist & Profit Strategies Radio Show Market Correspondent
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