MLPsHere's one way to know that investors the world over are seriously worried about the future: They're willing to invest in securities guaranteed to lose money.

Last month, Finland joined Germany and the Netherlands in offering government bonds with negative-yields -- they pay back less than you pay for them. The upside, presumably, being that you'll only lose a little money.
It could be worse.

In this country, it's not quite that bad, but U.S. treasuries and bonds -- which have been for decades viewed as a safe bet to get modest returns -- aren't returning enough to beat the 2% annual inflation rate. In essence, that means they're a guaranteed losing investment, too. But a poor return on investment, we are told, is the price for safety.

It doesn't have to be.

U.S. savers looking for better ways to capture profits can find them with a little creativity, and by looking beyond the traditional government-backed safe havens.

Consider, for example, this option that many investors aren't even aware of: the Master Limited Partnership, an increasingly popular high-yield investment vehicle in which 80% of income is tax-shielded. They're good for income-oriented investors, and also a smart buy for young people looking for defensive securities.

You Down with MLPs?

MLPs have the tax benefits of a limited partnership, but with the liquidity found in publicly traded securities. Investors -- known as unit holders -- purchase units of the partnership -- similar to shares of a stock -- through holding companies, and get paid quarterly distributions that are similar to dividends.

One big MLP advantage stems from the fact that the partnerships are mostly "pipeline"-related -- those involved with the transport or extraction of oil, natural gas or natural gas liquids. That's been key to their consistently impressive performance.

"Investors have this thirst for income," said Maury Fertig, CIO of Relative Value Partners in Northbrook, Ill. "For someone who wants income, but realized the bond market is not there, if they're willing to take a little risk, they're constructing a scenario where they can dip a toe in the market."

Think of MLPs as a hybrid between fixed-income instruments and equities: They have both high current income yields and stable, growing distributions, and have outperformed the S&P 500 in 11 of the last 12 years. There's also a low correlation of MLPs to equities, commodities, and fixed-income instruments -- in other words, they do well when those assets aren't, so they're good for portfolio diversification.


And MLPs provide a yield significantly higher than more well-known income-focused investments like utilities and REITs. At the end of the second quarter, MLPs had yields of 6.7%, compared to utilities at 4.1%, REITs at 3.4%, the S&P 500 at 2.2%, and 10-year Treasury bonds at 1.6%.

It's the MLP distributions, with their consistency and robust growth, that drive the investment's performance and make it a better hedge against inflation. "Your brokerage distribution drives half of your returns," explained Darren Schuringa, managing member at Yorkville Capital Management LLC in New York City.

The sort of distribution growth MLPs provide usually comes with some degree of compromise or risk -- but MLPs have been largely immune to that.

"More income usually means more risk [in an investment]," Schuringa said. "But distributions with MLPs have been more stable than REITs and utilities. There's no more risk of default or volatility in distribution. This would usually be indicative of a mispriced asset class, but it's not in this case."

How Do I Invest In MLPs, and Why Are They So Secure?

Any time someone starts telling you about an investment opportunity that has high returns and low risk, a wise investor will suspect something's fishy. But in the case of MLPs, this rare pairing of qualities has a reasonable explanation.

MLPs are both hot and stable right now because they're profiting from a major U.S. energy extraction boom. Fracking and horizontal drilling efforts have tapped into new reserves in shale gas, as in North Dakota's Bakken formation -- discoveries that bode well for attractive returns in energy sector-heavy MLPs.

The Bakken shale is providing attractive returns in energy sector-heavy MLPs. (Getty)

Many MLPs are invested in providing infrastructure to move oil and gas. Kinder Morgan (KMP), for example, is an MLP, and a natural gas pipeline operator. Think of it as a toll collector, earning fees from large energy companies for transporting their products.

Pipelines are a much more predictable business than extraction: They're far less subject to troubles when commodity prices fall, nor do they have to worry about the risks taken on buy those companies that drill for -- and sometimes fail to find -- oil or natural gas. And because regulatory approvals for new pipelines are hard to come by, these MLPs will have a virtual monopoly in the business for quite some time. For now, natural gas prices are strong, and -- another auspicious sign -- the crude oil to natural gas price ratio remains near its all-time high.

The Tax Benefits

Income from MLPs is tax-deferred, and given the fiscal cliff the U.S. is facing, that makes them a partial shield against potential upticks in the marginal tax rate.

MLP distributions are tax-advantaged because of a quirk in their corporate structure: They require a lot of capital expenditure, which gives them a huge shield of depreciation. Depreciation becomes an "expense," and because it appears on paper as greater than revenue, partnerships can show a loss on paper even though they are generating a lot of cash-flow. The partnership thus has money to distribute to its unit holders, 80% of which counts as tax-defered return on capital and not as current income.

"It's a tremendous advantage given the economic uncertainty we're facing in the U.S. now," Schuringa said. "If nothing happens, taxes are going to go up ... on distributions and capital gains."

"Investors should be putting assets into vehicles that will shield them from rises in the marginal tax rate," Schuringa said.

"From an investing perspective," he said, "no matter what happens with the election, I can sleep tight at night as long as these companies tend to pay their distributions."

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marthaburnham

how/where/contacts for master partnership(limited MLP

August 14 2012 at 9:22 PM Report abuse rate up rate down Reply
1 reply to marthaburnham's comment
marthaburnham

where do i get mlps 2nd try

August 14 2012 at 9:27 PM Report abuse rate up rate down Reply
1 reply to marthaburnham's comment
evd10

I'd imagine you could buy them at a brokerage firm.

August 14 2012 at 11:12 PM Report abuse rate up rate down
codrvr

Wait until April 15th to tell me how great MLP's are! I once held KMP until I had to fight my way through page after page of the partnerships K-1's in order to file my 1040. I've since sold the position and bought KMI instead. Much happier with Kinder-Morgan management. Any extra you might make with KMP will be quickly burned up by your tax preparer.

August 14 2012 at 8:17 PM Report abuse rate up rate down Reply
dfmarr

Since when are MLP's low risk? Also, they can blow up an IRA if you invest in them via that route.

August 14 2012 at 2:50 PM Report abuse rate up rate down Reply
ranovak

This article over simplifies the tax consequences of investing in MLPs. The MLP is giving back your money, ie., return of captial. This reduces your basis in the stock with time and may result in paying capital gains tax at the time of sale. There are other issues too. You should understand fully the tax implications before buying into MLPs.

August 14 2012 at 2:31 PM Report abuse rate up rate down Reply
ddginc

Have owned OKS (formerly Northern Border Partners) since 2000--payouts have ranged from 8% to current 4.6% & that is after 2 for 1 split in 2011. Has been fabulous investment w/minimal taxes. Also own EDP, TCP,PAA,ETP & NS. Sorry but this is not new news--MLP's have been very popular last couple of years-just look at MLP funds that have popped up!!!

August 14 2012 at 12:37 PM Report abuse rate up rate down Reply
kaybea123

the market always correlates yield with risk; the greater the risk, the higher the promised yield. you have to judge (guess) how accurate the ratio in this particulr deal, and if that level of risk fits your approval.

August 14 2012 at 11:42 AM Report abuse rate up rate down Reply
marino1949

How about tax implication in investing in MLP?

August 14 2012 at 10:47 AM Report abuse rate up rate down Reply