Is there a pipeline in your investment future? Master limited partnerships (MLPs) are a type of publicly traded holding structure employed widely in the natural resources energy infrastructure space, which includes pipelines, storage facilities and anything in the transportation chain, from the wellhead to the market consumer.
“Yield-starved investors are dying for ideas, so here’s an idea of a niche asset class that has high current income, growth potential and some tax-deferred characteristics,” says John Micklitsch, CFA, director of wealth management with Ancora Advisors LLC. “They bring some diversification to a portfolio because they have a low correlation with stocks and bonds, and they have the potential to hold up well in an inflationary environment because they are a hard asset and their distributions are growing.”
Smart Business spoke with Micklitsch about the advantages of MLPs and why this might be a smart investment for you.
How do MLPs work?
MLPs trade on major stock exchanges such as the New York Stock Exchange or NASDAQ like any corporate stock, but instead of being a common shareholder of a corporation, you are a unitholder in a limited partnership. Like stocks, there are no liquidity or minimum purchase requirements. Some MLP examples include Kinder Morgan Energy Partners (KMP) and Energy Transfer Partners (ETP).
Ninety percent of a MLP’s income must derive from natural resources production, transportation or storage, real estate, dividends or interest income. As it turns out, the majority of publicly traded MLPs are in the natural resources production, transportation and storage sectors. Basically, the government decided in order to have a strong energy infrastructure in this country, it would give companies participating in that infrastructure a subsidy by not taxing them, provided they distribute their income out to unitholders.
Why are they potentially attractive investments?
MLPs have the highly sought after characteristics of strong current income and future growth potential. The business model is very predictable and simple to follow, as MLPs are paid fees, based on long-term contracts, for the natural resources that go through their pipelines or storage facilities. Generally, midstream MLPs take no ownership of the underlying commodity and therefore have little or no exposure to commodity price volatility. This fee-based, steady income stream allows them to pay out high distributions.
The Alerian MLP Index, which represents the universe of publicly traded MLPs, showed yields above 6 percent as of June 30. Comparatively, utilities were around 4.1 percent, real estate investment trusts near 3.9 percent, the Dow Jones Industrial Average was 2.7 percent and the S&P 500 was 2.2 percent.
In addition, MLPs are predicted to grow because energy production is transforming due to the technological breakthroughs associated with horizontal drilling and the exploration and production of the country’s shale resources, known as fracking. Whether the newfound natural gas and oil is consumed in this country, as is likely, or exported, those resources are too valuable to sit in the ground and will find their way to market to the benefit of these volume-based infrastructure providers.
The distributions a given MLP would be able to pay are expected to grow 5 to 7 percent over the next several years. When added to current yields, you could be talking about potential low double-digit returns.
What else might impact MLP performance?
Many people are currently worried about inflation, but MLPs are hard assets. In addition, their distributions, which are not fixed and are expected to grow, stand a better chance of preserving people’s living standards in an inflationary environment.
When purchased directly, there are some potential tax-deferral benefits for investors, making MLPs and the income they produce potentially a tax-advantaged asset. However, it is important to work with an adviser to find the best ownership fit for you, direct or through a fund, as both have certain considerations.
One other advantage the MLP universe has exhibited in the past is a relatively low correlation with both the stock and bond markets, making them a good diversification tool. For example, in 2008 and 2009, MLP prices fell, but importantly, MLPs not only met their distributions but many of them continued to increase those distributions. MLP business models are very resilient to economic and commodity volatility.
What does the future look like for these investment vehicles?
The future is extremely bright for MLPs based on domestic energy production, led by this horizontal drill, shale/fracking revolution and simple demographics. The aging population will be starved for yield; interest rates are at an all-time low. MLPs’ combinations of high current yield plus distributions that should keep pace with inflation put them in a very attractive position for the key baby boomer demographic over the next five to 15 years.
In addition to yield-starved individual investors, institutions — endowments, foundations, defined benefit plans — are becoming more aware of MLPs and their benefits. Institutions could increasingly become involved in the MLP space over the next decade as they search for sources of return that allow them to hit their long-term actuarially driven targets. Even though they face the hurdle of unrelated business taxable income, it can be solved by a variety of ownership structures.
What should investors remember about MLPs?
MLPs are a very interesting asset class that’s growing in stature and awareness, due to the attractive combination of high current yields and growth potential of distributions, but MLPs do have several nuances that make their incorporation into your overall portfolio best accomplished with the help of an experienced adviser well versed in the space.
John Micklitsch, CFA, is the director of wealth management with Ancora Advisors LLC. Reach him at (216) 593-5074 or email@example.com.
Insights Wealth Management & Investments is brought to you by Ancora
When investors are seeking a financial adviser, they often make their decision based on price, figuring that everyone offers the same products. But that could be a mistake, says Frederick D. DiSanto, CEO of The Ancora Group.
“Instead of looking for the least expensive adviser, look for someone you can work with, with whom you feel comfortable and who has a real interest in helping you achieve your goals and objectives,” says DiSanto. “Pricing is always a concern and it should be commensurate with what is out there in the marketplace, but building that relationship with someone you trust is critical.”
Smart Business spoke with DiSanto about what to look for in a financial adviser and how to get the most out of the relationship.
What are some important traits of a good financial adviser?
The first thing to make sure of is that you are comfortable with that person, because it is all about the relationship. Is this someone with whom you feel that you can build a strong, solid working relationship — and friendship?
When looking for someone to manage your assets, that relationship is so important. You have to believe that once you set your goals and objectives and make that asset allocation, the adviser can execute. If issues arise, are you comfortable enough to call them in good times and bad? The stronger your relationship is, the better and the higher the probability will be that you will meet your goals and objectives.
The adviser should help you define your goals and risk tolerance, then provide solutions to meet your individual needs. There is no one-size-fits-all solution. An adviser should get to know you and your needs and not simply try to sell you products. Advisers should take the time to address a total risk management solution and take into consideration issues such as the riskiness of your career and your business and incorporate them into the risk profile of your investments.
This is not a five-minute conversation. It is an ongoing conversation in which the adviser helps you assess your goals, objectives and your stomach for risk to create an investment road map. Forming this type of relationship can really differentiate advisers.
The best advisers are not trying to push a product but are working to provide the best solutions to their clients. Your adviser needs to understand that not everyone is the same and that he or she has to mold, develop and create a total solution to accommodate your individual needs.
How would you define the adviser/client relationship today?
There is much more transparency because of the volatility we have seen in the market in the last few years, and there is much more communication between adviser and client.
Asset allocation is one of the most critical elements to understanding a client’s risk exposure. Throughout the past four years much more attention has been paid to a portfolio’s asset allocation. As the markets go up, people tend to be more aggressive and lose sight of their risk tolerance. Today, the focus is more on developing the right asset allocation, which will help investors weather any market conditions.
How often should investors meet with their advisers?
Every client is different, but an investor should meet with his or her adviser at least once a year, if not more, to review performance and determine if goals, needs or risk profiles have changed.
If there is going to be a life-changing event — for example, you want to retire in three years — you need to be communicating with your adviser about your goals and objectives so he or she can work to help you meet them.
How important is it for your financial adviser to work with your tax and legal advisers?
It is critical. Investors often have multiple investments, so having your financial, legal and tax advisers working together will help them better understand your total tax liability, gains and losses to create the most tax-efficient scenario. Your financial adviser should be providing your CPA with information about what your gains and losses have been on a quarterly basis to make sure nothing gets overlooked. And from an estate planning point of view, there is a lot of coordination to be done with legal advisers to ensure assets are held in the appropriate name, title, etc.
How should investors approach the issue of fees with their adviser?
The first thing an investor should look at is whether he or she can work with this adviser. Do you feel comfortable calling on Saturdays when you have a question or concern? If you believe you can work well together, then look at fees to determine how they compare to the marketplace and have a conversation about the discrepancies. If the adviser’s fees are slightly higher than the market that should not really dissuade somebody if the relationship fit feels right.
Is it fair for clients to ask their advisers for help with networking or other services for which the advisers don’t get paid?
Absolutely. Your adviser should go the extra mile to help you network. Having an adviser who can help clients build centers of influence and relationships outside their own network and help them grow professionally and personally is extremely important. It does not come out in the performance of your assets, but it comes out in your relationship. If you have a great relationship, your adviser will want to help you, whether it is with investments or business. It is not strictly what investments you make in your portfolio, it is also all those variables that you cannot put a hard number on.
Frederick D. DiSanto is CEO of The Ancora Group, as well as an investment advisor representative of Ancora Advisors LLC (an SEC Registered Investment Advisor). Reach him at (216) 825-4000 or firstname.lastname@example.org.
Insights Wealth Management & Investments is brought to you by Ancora