Analysts don't expect last year's gusher from oil and gas master limited partnerships to continue, but they are still recommending the deals for investors seeking income, tax protection and portfolio diversification.
Analysts don't expect last year's gusher from oil and gas master limited partnerships to continue, but they are still recommending the deals for investors seeking income, tax protection and portfolio diversification.
They like them especially be-cause MLPs distribute most earnings directly to investors, and when those earnings grow, so do returns.
The Alerian Capital Management LLC Index of MLPs returned 76% last year and an average of 23% since 2000, according to the firm's data.
“If I were in sales, I could spin a very good story around MLPs,” said Barry Berlin, managing director at Atlantic Trust Private Wealth Management, the $15.2 billion asset wealth management arm of Invesco Ltd., which offers a proprietary MLP product to its clients. “Stable and growing cash flow from an investment is a beautiful thing, and we still think the underlying fundamentals are sound enough to maintain diversification in the sector.”
The MLP portfolio certainly worked out well for Atlantic Trust last quarter. Although Mr. Berlin said that he couldn't provide any details of the firm's investments, due to legal restrictions, Invesco reported last month that the MLP strategy at Atlantic Trust generated virtually all of Invesco's $7 million in performance fees for the period.
MLPs help finance oil and gas pipelines, and are usually formed by energy companies to avoid double taxation. Unit holders of the partnership receive most of the cash earnings directly, and they pay tax only on a portion.
The rest is tax-deferred and lessens the cost basis of the investment. Taxes are paid on the balance when the MLP holding is sold or when the cost basis reaches zero.
MLPs are complicated when it comes to tax time, however (direct unit holders receive K1 forms instead of 1099s), and as such, MLPs are best-suited to high-net-worth investors who already own a diversified portfolio. Because of restrictions, MLP units can't be held in individual retirement accounts.
Another caveat is that because MLPs depend on the debt and equity markets to fund their expansion, they are subject to swings in the credit markets. Indeed, the reason they did so well last year was that they performed so abysmally in 2008. The Alerian MLP Index dropped 37% in 2008, on a total-return basis, but that was in line with the performance of the S&P 500. Investors who looked past the turmoil in the markets and focused on cash flows and fundamentals were rewarded, because commodities kept flowing even during the downturn, and very few MLPs lowered their distributions. The same can't be said of many other dividend-paying companies.
“MLPs came through the recession with flying colors, in terms of their distribution growth,” said Tom Neale, a vice president and MLP analyst at Wilmington Trust. “Almost none of them cut their distributions, and that certainly wasn't true for banks, [real estate investment trusts] and many utilities.”
Mr. Neale tracks pricing and performance of 79 MLPs for Wilmington Trust's equity managers, who manage $42.1 billion in client assets. He's presently recommending that managers consider 11 energy-related MLPs with an average yield of 7.7% for individual clients who need yield and moderate growth. Wilmington Trust has shares of four MLPs in its proprietary enhanced-dividend-income strategy. Last year, this strategy returned 22.7%, compared with 19.7% for the Russell 1000 Value Index, Mr. Neale said.
Leo Marzen, a principal at Bridgewater Advisors Inc., which has $825 million in assets under management and about 300 clients who have at least $2 million in investible assets, chooses to own MLPs through closed-end funds, which eases tax-reporting requirements for his clients.
Last year, the two closed-end MLP funds that Bridgewater owns, the Kayne Anderson MLP Fund (KYN) and the Tortoise Energy Infrastructure Fund (TYG), returned about 54% and 83%, respectively. Of course, that's the exception more than the rule, Mr. Marzen said, though the yields of about 8% on MLPs still keep him interested.
“The way we're thinking of it, we were delighted to get 80% returns last year, but we're not going to expect that going forward,” he said. “Future expected returns should be the current dividend yield, and perhaps 8% to 10% growth over time.”
MLPs are “attractive to any one who's an income tax payer,” Mr. Marzen added, “and they're desirable for stable income.”
With natural-gas exploration expanding around the United States, the sector likely will continue to grow, according to Jason Stevens, an analyst at Morningstar Inc. “On a total-return basis, the combination of yield plus the ability to grow distributions, quarter after quarter, have really propelled the group to really impressive performance,” Mr. Stevens said. “That's why there's investor interest in this space. Anyone getting low-double-digit returns from a stock in this market is doing all right.”
E-mail Hilary Johnson at -hjohnson@investmentnews.com.
