Master Limited Partnerships (MLPs) are starting to receive much interest as vehicles for Retirement investing. They are also a place to invest in companies with emerging growth prospects. While MLPs are not a new type of investment, the current level of interest indicates that they are starting to become part of mainstream investing. There is no doubt that there are good reasons to be interested in MLPs, particularly emerging growth companies and large-cap firms with attractive returns on equity (ROE) but do not yet have the scale or market presence to command high multiples or attract wide attention from institutional investors. These factors have driven the strong demand for MLPs over the last three years.
The Benefits of Investing in Master Limited Partnerships (MLPs) for Retirement
1. Tax Advantages
Many MLPs have attractive tax attributes for retirement investing. Return on equity (ROE) has been a significant factor in the rise of the stock prices of many MLPs over the last few years. ROE is an essential component of total shareholder return (TSR), which is a crucial measure of long-term returns as well as a critical part of traditional investment performance metrics such as return on investment (ROI) or return on equity (ROE). The tax attributes of many MLPs are also attractive for retirement investing.
2. Liquidity
The liquidity of large-cap MLPs is an essential feature for Retirement investing since cash-generating investments in low-liquidity stocks can feel like having your money tied up for years. The highly liquid nature of most MLPs makes it easy to sell them quickly, whether to take advantage of favorable tax rates or exit a position because you have made a good deal of money on a diversified investment strategy and are ready to move into equity index funds. Many MLPs, especially grocery stores and auto part companies, are widely held. It is usually easy to sell them quickly because so many investors own the same stocks, and you can find buyers for even short positions.
3. Diversification
The tax advantages of MLPs make some of them an excellent place to offer some diversification from the more traditional investment classes in your portfolio, such as large-cap stocks, bonds, and real estate investment trusts (REITs). While they are different types of investments, there is a similarity in the high dividends and strong cash flows characteristic of MLPs. The range of companies whose stocks are MLPs—from grocery store operators to timber firms, electric power companies to natural gas pipeline and storage businesses—also provides significant diversification.
4. Systematic Investing Strategies
MLP investing provides some exciting opportunities for systematic investing strategies. One reason is the high dividend yields on some prominent cap names: Enterprise Products Partners (NYSE: EPD) yields 6%, for example, and Kinder Morgan Energy Partners (NYSE: KMP) props up at a little less than 4%. These high yields make them attractive to investors who look for income streams as part of their retirement planning. They also make MLP investing a good place for investment strategies focusing on yield. As the correct type of investors begins to use a systematic investing approach, the opportunities in equity and international markets will increase significantly.
5. Late Entry
MLPs can be a good choice if you need some additional money but want to put only some of your eggs into one basket: a single large-cap stock or bond from another category of investments. It is particularly true if you have invested earlier in your career and are ready for some diversity in your portfolio or have an investment plan stretching out over several years. Many MLPs provide attractive yields that do not require an active portfolio management approach (in contrast, large-cap stocks have complex and time-consuming portfolio management). It can make it easier to keep your retirement plan on track.
The Risks of Investing in Master Limited Partnerships (MLPs) for Retirement
1. Volatility
The MLP sector is still in its early stages, and investors should expect more price volatility than they have seen. Prices have moved quickly up and down. It is especially true for smaller companies with fewer institutional investors and often no institutional ownership of the shares (this is a significant factor causing volatility among small-cap stocks). The risks of investing in MLPs are higher than with large-cap stocks widely held by institutional investors. There is also some danger that some MLPs will eventually be closed down or bought out.
2. The Investment Environment
The current climate of corporate financing and the economic situation, in general, could lead to more sell-offs and mergers in the MLP sector. It is a risk that comes with any investment, but investors should consider this possibility. It is also worth watching the industry trends since there could be more consolidations or mergers.
3. Unfavorable Tax Treatment
The tax treatment of MLPs can be unfavorable if they are held in a taxable account. As noted earlier, many MLPs have attractive tax attributes in retirement accounts (IRAs, 401(k)s, etc.) but may not hold up well for long-term investment if held in a taxable account. Dividends received from MLPs are considered ordinary income for tax purposes and are therefore taxed at the same rate as wages and salaries. Because of this, the tax benefit that accrues from the high yields generally available from MLPs is virtually eliminated for those investors who pay taxes at higher rates.
4. Choosing the Right MLPs
Public securities are no different from any other group of stocks in one sense: It is impossible to forecast their future performance accurately. It means that investors need to assess each company on its own merits rather than try and make a broad judgment about whether MLPs will generally do well or poorly based on the trends in the sector. Some are likely to do better than others, but predicting which will produce capital gains is difficult.
5. MLP Performance
For various reasons, the expected long-term performance from an MLP investment may be weaker than investing in the broad market. The following are just a few examples:
During 2008, the MLPs fell 44%, versus a loss of 34% for the S&P 500. It was mainly due to their heavy exposure to the energy sector, which took a beating in 2008. In 2009, several energy-related MLPs were hit hard due to their heavy exposure to natural gas and commodity prices.
In 2010, a number of MLPs also had tough years. Many of the largest energy-related MLPs suffered from low natural gas prices, low crude oil prices, rising interest rates, and declining gasoline demand.
During 2011, the MLPs rose 13% compared to a gain of 41% for the S&P 500 Index. The relatively small increase in performance was mainly due to the strong performance of specific industries like health care and consumer discretionary stocks. In addition, many companies that have long been in the sector performed well even though concerns about the economy and credit markets beat down their share prices.
MLPs are a relatively new type of company for investors, and their valuation and investment choices will continue to evolve. As this sector matures, the cash flows from MLPs will become more stable. Investors should be prepared to monitor the companies in this sector as they grow into one that is attractive to many investors in the future. MLPs generally make suitable investments for those who want some additional income. They also offer advantages in a wide range of portfolios because they can add some diversity to your investment portfolio and provide funds for Retirement.
