By John Wasik
CHICAGO Oct 12 There aren't too many places
left to look for higher yields these days. The usual go-to
baskets of high-yield and foreign bonds, REITs and high-dividend
stocks are pretty well picked over.
One little-known vehicle to Main Street investors is Master
Limited Partnerships (MLPs), publicly traded entities that own
assets such as pipelines. Because of their unique structure,
partnerships - which can be focused on energy holdings but may
also invest in alternatives such as timber and real estate -
generate a lot of cash that is distributed to limited partners.
Spurred by global and domestic demand for oil, refined petroleum
products and natural gas, for example, energy partnerships are
constantly expanding. In the last few years, the oil and gas
boom in North America has triggered robust growth.
Sparked by a combination of increased exploration and
recovery, indexes that track energy MLPs have outperformed
individual benchmarks representing utility companies, real
estate investment trusts and the S&P 500 index over the past 10
years, according to the Alerian MLP Index. In the decade ending
June 29, the MLP index returned 16.7 percent, compared to 5.3
percent for the S&P 500 Index and 10.7 percent for utility
In the past three years, MLPs have averaged 27 percent,
compared to 16.4 percent for the S&P 500. The partnerships have
mostly thrived because they have been linked to long-term energy
trends and not the global banking, credit and real estate
For investors interested in diversification, MLPs offer
returns that rarely follow in lockstep with big stocks. Since
they more closely track energy prices and not stock-market
sentiment, their correlation of 0.48 to the S&P 500 is
relatively low, compared to 0.74 for real estate investment
trusts, publicly traded companies that own properties. A perfect
correlation is 1.00. The lower the correlation with common
stocks, which tend to dominate most growth portfolios, the more
protection you'll obtain from equity sell-offs.
MLP holdings can be desirable if you're heavily invested in
common stocks, but there are other trade-offs that make them
more volatile and costly.
Here are five tips for getting the most out of your
1. For lower risk, don't buy individual partnerships.
If you buy individual MLPs, you're over-exposed to a single
company. And they may be illiquid, meaning if you wanted to
sell, you'd be unable to sell quickly. Since you become a
partner when you buy them directly, you also have to deal with
K-1 tax forms, which make your tax planning more complex and
2. Look for ETFs that package MLPs.
A handful of exchange-traded, mutual and closed-end funds
hold MLPs. If you hold partnerships through these vehicles,
you're relying upon managers to buy a mix of companies that
affords you some diversification and reduces your single-company
3. Get a broad mix of MLPs.
The ALPS Alerian MLP ETF holds big-name
energy/pipeline partnerships like Kinder Morgan Energy
and Enbridge Energy. The fund is yielding almost 6
For a more diversified mix, consider the First Trust North
American Energy Infrastructure fund, which has 36
percent of its portfolio in long-established utility companies
such as Dominion Resources and the Southern Company
. The First Trust fund is up 5 percent for the three
months through Sept. 29. It opened on June 19 of this year.
4. Understand the Risks.
While MLP funds offer you a variety of partnerships in one
package, they are not risk-free. Their values are linked to
commodity prices. If there are dips in oil or gas prices or
oversupply issues, their prices will suffer. Since they tend to
specialize in a small segment of the energy business, MLP funds
are concentrated in a small number of companies that will often
move in the same direction. They are not guaranteed in any way
and their tax treatment can be complicated.
And if oil or natural gas prices collapse, you'll be at even
more risk; they are much more volatile than stocks or bonds. The
five-year standard deviation, a gauge of volatility, on the
Steelpath Select 40 A fund, for example, is 33,
compared to 20 for the Vanguard 500 Index fund, which
holds the most popular U.S. common stocks, as of Oct. 10. The
lower the standard deviation, the lower the price variance.
These are not investments for nervous Nellies.
5. Know the costs.
You are also paying for the convenience of owning multiple
MLPs. The ALPS product, for example, charges 0.85 percent
annually for expenses, compared to 0.57 percent for the industry
If you think of MLP funds as limited ways of boosting your
income portfolio, don't get too concentrated in them because
while you're boosting yield, you're also adding considerably
more risk and investment management fees. They are not
substitutes for core holdings like broad-based bond and stock