Tag Archives | MLPs

How to Buy MLPs: Individual MLPs vs. MLP ETFs

Master limited partnerships have become wildly popular over the past decade, and it’s easy enough to see why. Collectively, they are the highest yielding major asset class available, and the 10-year cumulative total returns are an eye popping 328%, as measured by the Alerian MLP Index. (And yes, those returns include the carnage of 2008 and early 2009.)

Still, a lot of investors are intimidated by MLPs because of their perceived complexity. They shouldn’t be. While the tax issues aren’t fun, that’s what TurboTax and CPAs are for.

This brings me to the crux of this article. A host of ETFs, ETNs and mutual funds have cropped up to satisfy investor demand and provide an “IRA-friendly” alternative. The JPMorgan Alerian MLP ETN (AMJ) is the largest and most popular, but the ALPS Alerian MLP ETF (AMLP) and Oppenheimer SteelPath MLP Income Fund (MLPDX) are also popular options.

Today I’m going to go over the pros and cons of investing in these funds vs. building a portfolio of individual MLPs.

Diversification

For instant diversification, you have to go with a fund … but most funds are not as diversified as you might think. The top 10 holdings of the Alerian MLP Index — which serves as the benchmark for many MLP funds and includes companies such as Enterprise Products Partners, LP (EPD), Kinder Morgan Energy Partners, LP (KMP) and Plains All American Pipeline, LP (PAA) — account for 61% of its market cap. The top 15 holdings account for 72%.

Most investors — particularly if they are long-term income investors — would have no problem buying 10 to 15 individual MLP holdings. And with online trading commissions generally lower than $10 per trade these days (and given that dividend reinvestment is often free), it’s not cost-prohibitive to do so.

Cost

This brings me to the next consideration: cost.

Most MLP funds are maddeningly expensive to own. Both AMJ and AMLP — which are passive index products — have expense ratios of 0.85%, which is nearly as much as you would expect to pay for active management. MLPDX’s expense ratio comes in at 1.35%.

Given that most investors buy MLPs for their yield — and given that a “decent” MLP yield these days is 5%-6% — an 85-basis-point haircut is going to be felt.

Let’s take a look at some numbers. In a $100,000 MLP portfolio split across 15 individual holdings, you would pay $150 or less in trading commissions to get started. If your broker allowed for commission-free dividend reinvestment, you would have no additional costs. Ever. That same $100,000 invested in AMJ or AMLP would cost $850 per year to own, every year you own it.

Taxes

This is where it gets messy.

MLPs avoid corporate taxes by being organized as partnerships. In a nutshell, this means they have 35% more cash at their disposal to distribute, which is why MLPs are able to offer such high yields. But because MLPs generate “unrelated business taxable income,” they should never be held in an IRA account. Doing so can create a tax nightmare in which you have to file a separate tax return for your IRA.

And there is really no advantage to putting an MLP in an IRA. MLP distributions are generally not taxable for the first several years of ownership due to large non-cash expenses that cause the distributions to be classified as “return of capital” rather than current income. These have the effect of lowering your cost basis and thus raising the capital gains taxes you’ll owe when you eventually sell. Once your cost basis reaches zero — which might take multiple decades — your distributions are fully taxable at your marginal tax rate. It’s a pretty sweet deal.

The taxes on MLP funds will make your head swim. The distributions made by AMJ are considered bond interest by the IRS and are thus taxed as ordinary income. And AMLP, in a departure from normal fund tax structure, opted to be structured as a corporation and pay taxes at the corporate level. This has the effect of making its effective expense ratio of nearly 5% as opposed to the quoted 0.85%.

I see no reason to ever own AMLP.  And AMJ is generally the “least-bad” option for investing in MLPs within an IRA.

My advice? Hold your regular MLPs in a taxable account and learn to tolerate the annual K-1 tax forms. It’s an annoying headache, but you’ll enjoy higher returns and pay less in taxes and fees. If you are limited to IRA investing, then go with AMJ or a substantially similar security. In IRA accounts I manage, this is precisely what I do.

There is one exception I should note. MLP general partners are often structured as corporations and are thus able to be held in IRA accounts with no complications. General partners can be thought of as “leveraged” MLPs because of their incentive distribution rights. Without getting into the nitty-gritty accounting details, the general partner gets a larger share of the payout every time an MLP raises its distribution.

Two general partners I own and recommend are Kinder Morgan Inc. (KMI) and Williams Cos. (WMB). Both have been dividend-raising monsters in recent years and sport current yields of 4.5% and 4.2%, respectively.

Charles Lewis Sizemore, CFA, is the editor of the Sizemore Investment Letter and the chief investment officer of investments firm Sizemore Capital Management. As of this writing, he was long EPD, KMP, PAA, AMJ KMI and WMB. Click here to learn about his top 5 global investing trends and get your copy of “The Top 5 Million Dollar Trends of 2013.”

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

Read full story · Comments { 2 }

Is the Bull Market In REITs and MLPs Over?

Over the past 10 days, a period where the S&P 500 has traded sideways, REITs and MLPs are down 8% and 6%, respectively, as measured by the Vanguard REIT ETF ($VNQ) and the JP Morgan Alerian MLP ETN ($AMJ).

Chart

Individual REITs and MLPs got hit harder.  The popular Realty Income ($O) and Martin Midstream ($MMLP) were down 15% and 10%, respectively.

Ouch.

All of these securities have one thing in common: they have become extremely popular with yield-starved income investors in recent years.  And the Fed’s recent pronouncements—which indicate that quantitative easing may be ending sooner than expected—slammed them in response.

So is that it?  With rates now destined to rise, is the bull market in income-focused securities over?

Not so fast.  To start, it is not entirely certain that interest rates will materially rise.  Sure, we probably won’t see the 10-year note at 1.5% again (or mortgages at 3.3%).  But as the experience of Japan has proven, rates can stay much lower for much longer than anyone expects during a prolonged period of deleveraging and aging demographics.

The U.S. is not Japan, of course.  But we have a supply/demand mismatch in the fixed income market.  Supply of fixed income from government and private-sector borrowers has not kept up with demand for fixed income by retiring Baby Boomers.  Putting it another way, there is a surplus of investable funds out there, and that surplus means that the price of money—i.e. interest rates—will likely stay low irrespective of what the Fed does.

In other words, don’t expect to see 4-5% Treasury note yields any time soon.

But beyond this, even if yields do rise modestly, a well-bought portfolio of REITs and MLPs can offer something that a standard bond portfolio cannot: an income stream that rises over time.  With demand for pipeline infrastructure charging ahead and with the U.S. commercial real estate markets continuing to improve, the fundamentals of REITs and MLPs as a group are strong and looking to get stronger.

That said, investors had gotten a little carried away this year.  Realty Income and Martin Midstream had been up by as much as 35% and 45%, respectively, since January 1.  They needed a correction…and they got it.

Where do we go from here?

I continue to like both REITs and MLPs as asset classes for the next 5-7 years.  But it’s never good trading advice to try to catch a falling knife.  I would recommend averaging into your favorite REIT and MLP shares on any additional weakness.  You don’t have to buy your entire target allocation in one trade;  buy on dips to enjoy a lower cost basis and plan on holding for a while.

If I’m wrong—very wrong—and inflation goes through the roof in the years ahead, REITs and MLPs will take a hit, at least initially.  But both also have a degree of built-in inflation protection in that real estate and pipeline assets should hold their value in real terms even while the debts used to finance them get inflated away.

Disclosures: Sizemore Capital is long O, MMLP, AMJ and VNQ.  This article first appeared on TraderPlanet.

SUBSCRIBE to Sizemore Insights via e-mail today.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

Read full story · Comments { 0 }

MLPs: The Ultimate Asset Class for 2013

I saw a headline this week that really caught my eye: “Saudis Cut Oil Output to Lowest in a Year.”

Generally, Saudi Arabia cuts its oil output for one and only reason: demand has slackened due to a weak economy, causing the price to fall.  But then, that was before “fracking.”

The Saudi move to cut supplies has little to do with demand, as growth has been lackluster for most of 2012.  This time, it has everything to do with supply.  U.S. domestic oil production rose by 760,000 barrels per day this year—the biggest increase since records began being kept in 1859. And this is just oil; I’ve said nothing at all about natural gas, of which the United States now produces far more than it can use.

And in an unrelated story, Fed Chairman Ben Bernanke gave the markets a jolt this week by announcing that “QE Infinity” will be even larger than originally planned.  Rather than “only” buying $40 billion in mortgage securities per month, the Fed would also be buying $45 billion in Treasuries.  That’s $85 billion per month in new cash being dumped into the system.

Oh, and Bernanke also plans to keep short-term rates at zero until he sees the unemployment rate dip below 6.5%.

I bring up these two seemingly unrelated points for a reason.  The combination of higher volumes of domestic oil and gas being pumped and the loosest monetary policy in history should make mid-stream master limited partnerships one of the safest bets for 2013.  The fundamentals for domestic energy haven’t been this good in decades.  And as yield-sensitive investments, MLPs are a no-brainer in a world of zero interest rates.

Even better, we have a chance to buy them on the cheap.  The whole sector has taken a beating after the election due to fears of higher taxes coming.  Investors who have owned MLPs for years—and who had large unrealized capital gains—have decided to take their medicine today rather than wait for the inevitable.

Well, the end of the year is approaching fast, and the tax-loss selling should have mostly run its course.

Action to take: Buy the JPMorgan Alerian MLP Index ETN (NYSE: $AMJ).  Alternatively, if you are buying with the intention of holding for a while, assemble a portfolio of individual MLPs.

As with dividend paying stocks, there is often a trade-off between high current yield and prospects for growth.  Higher yielding MLPs often times have low expected distribution growth.  So keep that in mind when researching the sector.  And if you would prefer a “one stop shop,” then AMJ is a decent option that also happens to be IRA friendly.

Though this is website dedicated mostly to shorter-term trading, my recommended time horizon on these is longer-term.  I recommend holding MLPs for the duration of Bernanke’s “QE Infinity.”  That means holding until either the unemployment rate shows meaningful improvement or until inflation starts to creep up.   For risk management, consider something along the lines of a 15-20% trailing stop.

Disclosures: Sizemore Capital is long AMJ in its Strategic Growth Allocation.  This article first appeared on TraderPlanet.

SUBSCRIBE to Sizemore Insights via e-mail today.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

Read full story · Comments { 2 }