Master Limited Partnerships

By Richard Stooker

In a low yield world where government bonds pay next to no interest, S&P 500 stocks pay little more than that in dividends, the Canadian government is on the threshold of taxing income trusts, and even real estate investment trusts are suffering cash flow problems, one type of security still stands as a beacon of hope to income investors. 

Master Limited Partnerships or MLPs 

9% yields . . . that increase 9% annually . . . quarterly distributions almost guaranteed . . . capital gains that leave the S&P 500 in the dust . . . tax protection . . . business profits protected by federal government regulation . . . profit from the energy sector without the volatility of market prices because MLPs are paid by volume not final price. 

Until now, the information available to investors has been scanty. There've been only chapters in books. One prominent financial advice company recently launched a newsletter devoted to them, but the price tag is $399 annually. The Internet contains summary but incomplete articles and snatches of advice (some good, some inaccurate). 

Finally, investors can learn all about these terrific investments -- their rewards and risks; the paperwork hassles and how to get around them; and how to invest in them using both taxable and tax-deferred accounts. 

In one convenient volume for one low price. This book is the first and only devoted solely to Master Limited Partnerships. 

You'll discover: 

The incredible benefits of Master Limited Partnerships 

Why they're still incredibly cheap 

How their legal rules and business structure combine to send you lots of cash 

Why they'll continue to generate lots of cash for the foreseeable future 

Information on every company Information on every MLP index 

Information on every MLP closed-end fund 

What MLP i-units are and how they can skyrocket your IRA portfolio 

How to understand and complete MLP tax forms 

Everything you need to know to get started to enhance your current income or save for your financially secure future. 

I cover a lot of material that applies to all energy-related MLPs, but my strong recommendation is you confine your investment dollars to those in what are called "midstream" MLPs. More on that later.

I'll start off with a chapter that explains the many benefits of investing in midstream Master Limited Partnerships.

Followed by a chapter on the "catches" -- the aspects that individual investors sometimes stumble over.

Followed by information on the business risks of MLPs.

Then information on their history, structure and businesses both from the financial side and the petroleum industry side. This includes why businesses convert their assets to MLPs. And why such high yielding investments are still available in today's otherwise low-yield financial marketplace.

Then we'll cover everybody's favorite topic -- taxes. The tax and tax filing consequences of owning MLP units. I'll also cover the various tax forms and how to complete them.

Then ways of investing in MLPs that, in terms of tax paperwork and filing, are the same as investing in stocks. So you can add MLPs to your tax-deferred accounts or simply avoid the extra paperwork created by direct ownership of MLP units.

There're chapters on MLP i-units, on each MLP-related closed-end fund and MLP Exchange Traded Notes.

Then there're chapters on all the MLP indexes.

Then tips on putting this information all together to benefit from MLPs in your taxable broker account and your tax-deferred accounts. 

And how to balance MLPs with the rest of your portfolio.

Then a chapter on what happens if you -- against my advice -- sell MLP units.

• Language: English
• Publisher: Richard Stooker
• Release date: Aug 5, 2015
• ISBN: 9781516362691

Book preview

Introduction

I wrote this book because nobody else did.

You can buy books about Real Estate Investment Trusts (REIT), Canadian income trusts, ordinary dividend paying stocks, bonds and utility stocks. You can buy books that have a chapter or appendix about Master Limited Partnerships.

But—until now—you could not buy a book devoted solely to Master Limited Partnerships.

I cover a lot of material that applies to all energy-related MLPs, but my strong recommendation is you confine your investment dollars to those in what are called midstream MLPs. More on that later.

I’ll start off with a chapter that explains the many benefits of investing in midstream Master Limited Partnerships.

Followed by a chapter on the catches—the aspects individual investors sometimes stumble over.

Followed by information on the business risks of MLPs.

Then information on their history, structure and businesses both from the financial side and the petroleum industry side. This includes why businesses convert their assets to MLPs. And why such high yielding investments are still available in today’s otherwise low-yield financial marketplace.

Then we’ll cover everybody’s favorite topic—taxes. The tax and tax filing consequences of owning MLP units. I’ll also cover the various tax forms and how to complete them.

Then ways of investing in MLPs that, in terms of tax paperwork and filing, are the same as investing in stocks. So you can add MLPs to your tax-deferred accounts or simply avoid the extra paperwork created by direct ownership of MLP units.

How to Invest in MLPs—All Aspects

There’re chapters on MLP i-units, on each MLP-related closed-end fund and MLP Exchange Traded Notes.

Then there’re chapters on all the MLP indexes.

Then tips on putting this information together to benefit from MLPs in your taxable broker account and your tax-deferred accounts.

And how to balance MLPs with the rest of your portfolio.

Then a chapter on what happens if you—against my advice—sell MLP units.

And a chapter on what happens if you follow my advice and hold your MLP units until you die.

Then chapters on each individual energy or natural resource related MLP available today.

If there are any omissions or errors I need to correct in a future edition (if any), email me at—[e-mail] .

Chapter 1

Why You’re Going to Love Master Limited Partnerships

Before we get into a lot of detail, let me explain up front the bottom line—

Smart Investors—With One Exception—Should Love Master Limited Partnerships

There’s a lot of reasons for that, and I hope you’ll read the best of this book so you understand I’m not speaking off the top of head and so you believe what I’m saying.

(What’s the one exception? Tax-deferred accounts such as IRAs, 401(k) plans, the government’s Thrift Savings Plan, 403(b) plans, Keogh plans and all other such accounts should never own MLP shares. I’ll explain why in a later chapter. I’ll also examine the various ways people try to get around this, and why they all—in my opinion, fall short. For now all you need to know is that for ordinary, taxable individual portfolios, MLPs are WONDERFUL.)

But I want you to know—from the get-go—why reading this book (and of course, actually acting on this information) will make you money.

Lots of money.

Master Limited Partnerships—

1. Pay out large amounts of cash on a quarterly basis.

This varies, but it’s not unusual to find MLPs yielding an average of seven or eight percent.

If you buy an S&P 500 index fund, you’ll receive a 1.78% yield (as I write these words in February 2010). If you count only the S&P 500 stocks that actually pay a dividend, you’ll still receive only 2.42% yield.

And that’s in a stock market which is still below a high it broke in April 1999.

2. For about the first five years you own units of an MLP, roughly 80% of that cash is NOT taxable until and unless you sell your units. If you never sell them, you never pay taxes on that part of the income you received from them.

3. That quarterly cash generally goes up every year. That’s not guaranteed or universal of course, but the historical average is around 9% annual growth.

2008 and 2009 were hard on some MLPs, but not as hard as they were on the rest of the world’s financial markets.

4. Over the past fifteen years according to one of the MLP index, the types of MLPs this book concentrates on have gone up in market price 550%. That’s an average compound total annual return of 14.5%.

The S&P 500 has gone up 120%, or just 5.6% annually.

Those are averages, but the only period MLPs as a whole did not go up in price more than the general stock market was 1998-1999, the height of the dot com high tech boom.

For the twelve-month period ending October 31, 2009 (one of the most unnerving periods in the history of the financial markets), MLPs posted a gain of 24.22% while the S&P 500 went up just 9.80%.

And remember—the broad stock market is right now still about where it was in April 1999.

5. The amount of cash paid quarterly has one-third the volatility of the S&P 500 stock dividends. That means your cash income from MLPs is three times as likely to remain high or higher than dividends from average S&P 500 stocks—which can be cut. During the current recession, many were.

6. Market performance does not correlate strongly with the stock market.

This means MLP share prices can rise even while the S&P 500 market is going down. Therefore, owning MLPs can act as a hedge on your portfolio.

I must point out, however, this is historically true in the long run, BUT in the financial crisis of 2008 through March 2009 ALL securities suffered, MLPs included (but not as much as most types of investments).

7. Are in a business with high and relatively inelastic demand—energy.

Energy demand does fluctuate, and during the 2002 and current recessions, it remained flat—but not down.

8. Are in a business with growing demand.

Experts believe American demand for energy will continue to grow at least 1% per year for the next twenty years.

9. Do not depend on a high price for gas on oil.

During slow economic periods, the price for oil goes down. But that doesn’t affect MLPs. Unlike oil companies, MLPs make a profit whether oil is selling for $10 per barrel or $150.

10. Prices are set by regulators who guarantee they make a profit.

MLPs are regulated by the Federal Energy Regulatory Commission (FERC). They’re guaranteed a profit, much like utilities. However, unlike utilities, they’re not required to share cuts in expenses with their customers.

This means a good management team has an incentive to cut costs as much as possible—which means more money for you.

11. If and when society transitions to alternative, non-petroleum based sources of energy, many MLPs can be converted to ethanol and hydrogen.

Mmm, Let’s See…

An investment that pays out a quarterly cash yield about four times the S&P 500 average, and is largely tax deferred until you sell the security (which means taxes can be forever deferred), and that distribution grows an average of 9% annually, and that security price goes up faster than the S&P 500 average even when the S&P 500 market falls, and which is in a business necessary to civilization as we know it, with price protection enforced by the government, and with a future all but assured…

If you’re not excited yet, you need to check your pulse or you’re so rich already you’re bored by money.

So by now you’re probably like the people in some radio ads, asking, What’s the catch?

Chapter 2

The Catches of Investing in Master Limited Partnerships

There are four.

1. As mentioned above, MLPs are NOT for tax-deferred accounts.

Frankly, if your entire investment portfolio is a tax-deferred account, direct ownership of Master Limited Partnerships are not—yet—for you. But there are ways you can benefit from their extraordinary cash flow. I cover these in a later chapter.

2. In February or March of every year, you receive a partnership tax form K-1 instead of an ordinary 1099 in January.

Frankly, K-1 forms are a lot more complicated and confusing than an ordinary 1099 form.

And they require you keep good records, which you should do anyway.

That’s why there’s a chapter on them in this book. If you do your own taxes, you’ll learn what you need.

Plus, any competent accountant knows how to use a K-1 form to prepare your tax return. So if you don’t do your own taxes, you don’t have to sweat about it all.

And almost all MLPs use an online service to export your K-1 information to Turbo Tax.

3. With some MLPs, you’re legally supposed to report your earnings to every state in which the MLP does business.

4. If you are foolish enough to sell your MLP units, your original tax basis amount is taxed as ordinary income. If the price you receive back is higher, the difference is taxed at capital gains rates.

You can obviously avoid this catch, simply by never selling your MLP units. That’s my advice.

Maybe you’re thinking there must be another catch, something else I’m not telling you.

I don’t blame you for not believing all the above benefits. They sound too good to be true, like a fairy tale.

That’s the purpose of the remainder of this book—to explain Master Limited Partnerships in detail, so you understand the technical, legal and practical reasons why they’re such great investments.

They seem like perfect businesses to invest it, but there’re always risks.

Chapter 3

The Risks of Master Limited Partnerships

No investment is free of risk. Therefore, I’ve compiled a list of the risks faced by Master Limited Partnerships.

1. Business risk

Some management teams simply perform better than others.

2. Regulatory risk

There’s always the possibility Congress could someday change the regulatory structure, law, regulations or practices of the Federal Energy Regulatory Commission (FERC) to something less favorable to MLPs.

That does not appear likely right now, but nobody can predict the future.

Their trade group, the National Association of