Master limited partnership exchange traded funds can help investors gain exposure to the expanding U.S. energy infrastructure while generating attractive yields with lower volatility.
MLPs own and operate pipelines, refineries, transportation, storage and distribution businesses - the backbone of the energy sector, writes Stephen Maresca, energy analyst at Morgan Stanley, in a research note.
These companies generate revenue by handling or transferring the commodity. They act like a toll road in the energy highway, so MLPs are not affected by the price fluctuations of the underlying commodity. Additionally, barriers to entry into the MLP business is high.
The MLP company is structured as a pass-through partnership where each investor holds a "unit" of the partnership instead of shares of the corporate stock. Due to the way they are structured, MLPs do not pay corporate-level taxes, but unitholders will have to bear the burden, paying at their individual tax rates.
"The mean yield in the partnerships we cover is 5.9%," Maresca said. "This year, we estimate that MLPs will, on average, pay unit holders a 7.6% growth rate on cash distributions. We expect that payout to rise another percentage point in 2014 and 2015."
Moreover, a large portion of the distributions is taxed deferred - taxes are not paid when the funds are received, but rather when the investment is sold.
The MLP investment has shown low levels of volatility, with an average beta of 0.72, or 72% that of the broader equity market, over the past three years. In addition, over the past 12 years, the Alerian MLP index and the Cushing 30 MLP index have earned an annual total return of 20.5% and 23.6%, respectively, compared to the S&P 500′s 4.5%.
"With less cash-flow volatility, MLPs have demonstrated low volatility as equity investments," Maresca added. "We believe this asset class will continue to perform well longer term given the increased demand for US infrastructure needs, but that gains will come at a less pronounced pace."
Investors interested in MLPs can take a look exchange traded options like the JP Morgan Alerian MLP Index ETN (AMJ), which has a 0.85% expense ratio and a 4.56% yield, or the Credit Suisse Cushing 30 MLP Index ETN (MLPN), which has a 0.85% expense ratio and a 4.61% yield. Both funds are up about 27% year-to-date.
Max Chen contributed to this article.