With interest rates continuing to hover in the basement, investors looking for income have had to scour all sorts of asset classes in order to get their yield fix. From real estate investment trusts (REITs) to convertible bonds, nothing seems to be off-limits in the quest for yield. One of the biggest beneficiaries of investor’s newfound hunt for income has been master limited partnerships (MLPs)
The key is that due to their tax structure MLPs are required to pay most of their cash flows back to investors in the form of juicy distributions. Just how juicy? Try the 5% to 9% range on average. That fact has made them a great place to find relatively stable and steady income in the current environment.
But even investors who aren’t looking for income may want to consider MLPs. They are total return machines.
Total returns for MLPs have pretty much destroyed almost every asset class — from stocks to bonds — over the last 10 years. For investors, adding a dose of MLPs could be one of the biggest wealth creators for their long-term portfolios.
MLPs’ Primetime Performance
Back in the 1980s — in an effort to boost dwindling energy infrastructure investment — congress tweaked the tax code so that firms engaged in the “exploration & production, development, mining, refining, transportation or the marketing of any mineral or natural resource” could set up an MLP and pay no corporate tax on the assets in the vehicle.
Designed as “pass-through entities” — similar to REITs — MLPs by definition are required to pay large distributions to their unit holders. The general partner (GP) or sponsoring firm of the MLP, receives tax benefits by “dropping down” assets and dividends via the units it owns and incentive distribution rights (IDRs) from the MLP.
For an income point of view, the tax-structure is amazing. But from a total return point of view, it’s even more amazing
That’s because the majority of MLP cash flows are based on the volume of oil or gas that flows through their pipes — independent of the value of that liquid. With more and more energy activity happening in the U.S., demand for MLPs pipelines, gathering and processing facilities has exploded. That demand has pushed up cash flows on average. Since 2001, distribution growth for MLPs has averaged 7.8%. That’s about 3.4 times greater than rates of inflation and rising interest rates.
And over time, investors have continued to flock towards MLPs for those steadily rising cash flows.