I have written before about Master Limited Partnerships (MLPs); these investments generally focus on energy infrastructure and have been attractive to yield oriented investors. Because MLPs are partnerships, investors receive K-1s each year and can face somewhat complicated tax calculation issues. As the comments on my earlier article suggest, there is a divergence of opinion on the question of how nettlesome these tax problems are. In any event, investors can generally avoid the tax issues associated with direct ownership of MLP shares by buying MLP closed end funds instead. While I am not a tax lawyer and this article does not purport to give investors actionable tax advice, as a general matter an owner of shares in an MLP closed end fund will not receive a K-1, but will receive a 1099 instead and will not be faced with any tax problems beyond those normally associated with closed end fund ownership.
MLP closed end funds have become increasingly popular with a number of new entrants in the market recently. This article will provide some basic metrics with respect to MLP closed end funds in operation long enough to establish a track record. Thus, the article will not include data concerning three recently launched MLP closed end funds: ClearBridge American Energy (CBA), Cohen & Steers MLP Income and Energy (MIE), and Neuberger Berman MLP (NML). I have excluded any funds with respect to which MLP assets are less than 75% of total assets and, thus, Cushing Royalty and Income (SRF) (71%) and First Trust MLP & Energy (FEI) (65%) are also excluded.
With respect to ClearBridge Energy (CEM), ClearBridge Energy MLP Opportunities (EMO), ClearBridge Energy MLP Trust (CTR), Cushing MLP Total Return (SRV), Fidelity/Claymore MLP Opportunity (FMO), First Trust Energy Income and Growth (FEN), Kayne Anderson Energy Development (KED), Kayne Anderson Energy Trust (KYE), Kayne Anderson Midstream (KMF), Kayne Anderson MLP (KYN), Nuveen Energy (JMF), Salient Midstream (SMM), Salient MLP (SMF), Tortoise Energy Capital (TYY), Tortoise Energy Infrastructure (TYG), Tortoise MLP (NTG), and Tortoise North American Energy (TYN), the table below provides Friday's closing price, the premium or, if negative, the discount to net asset value, total assets, leverage, and total fee and expense percentage (excluding interest expenses). Sources for the data are CEF Connect, which provides helpful information on closed end funds, the Closed End industry website and SEC filings of individual companies.
A few points are in order. The sector has grown recently with a number of new entrants and in many cases there is not really much of a "track record" to analyze. The closed end funds (CEFs) tend to invest in the same large MLPs so that there may not be a wide divergence in performance going forward. Almost all of the CEFs tend to have leverage clustered around 20-25%. The above group includes some CEFs, which invest in assets other than MLPs; for example, FEN (85%), KMF (78.5%), KED (89%) and SRV (85%) all have substantial non-MLP assets although MLP allocation is above my arbitrary 75% cut off. The MLP CEFS vary in investment orientation and can focus on different subgroups of MLPs. Investors should be aware that there has been significant variation in MLP performance over the past year or so (for example, coal MLPs have generally underperformed). Because of the size of the group, a detailed CEF by CEF analysis is beyond the scope of this article. However, I may write follow up pieces on individual CEFs or groups of CEFs in the near future.
A legitimate issue for investors is whether to simply invest in a group of MLPs or to opt for a CEF or group of CEFs. A reasonably diligent investor may be able to achieve diversity (among publicly traded MLPs) comparable to that achieved by CEFs by buying a group of the leading MLPs. On the other hand, the CEFs can and sometimes do invest in non-publicly traded assets which would be hard or impossible for a typical investor to access. The CEFs do add a layer of non-trivial management fees and expenses, which can be avoided by buying MLPs directly. On the other hand, CEF leverage may partially or completely offset management fees. For example, a CEF with management fees of 1.5% of net asset value, which has 30% leverage and pays interest at 3% but achieves an 8% return on assets should make enough net return on the leveraged assets to offset the management fee. The disadvantage is that, if MLPs begin to decline in price (possibly due to higher interest rates or concerns about earnings) a leveraged CEF will tend to decline faster and further than a non-leveraged basket of MLPs. Thus, it may be that the main selling point of these CEFs is tax simplification and the avoidance of K-1 hassles.
I think MLP CEFs have a place in a yield oriented portfolio and may outperform a number of other yield oriented vehicles in a rising interest rate environment. As with a number of other equity yield oriented investments, I would not advise an "all eggs in one basket" approach to these CEFs but combined with BDCs, utility stocks, mortgage REITs, equity REITs, and dividend stocks, MLP CEFs allow an investor to generate a high single digit yield with the possibility of growth.