MTP's Lost NAV: 'C' Corporation Structure Highly Relevant

by: Dan Plettner

Nuveen’s MLP & Strategic Equity Fund Inc (NYSE:MTP-OLD) announcement Friday morning explained its dramatic one day decline in Net Asset Value (“NAV”) between Wednesday ($18.58) and Thursday’s close ($17.42). Like AMLP the fund is taxed as a “C” Corporation. MTP must currently accrue for potential future tax obligations; $1.05 of the NAV decline came from a deferred tax provision reflecting potential future tax obligations attributable to unrealized net appreciation in the fund's investments.

I have no long or short position, nor desire any position. MTP’s market price took a comparable hit ($0.83 of $1.05) Friday, but I would argue the greatest truth explained by the announcement was not specific to MTP. Rather, the “C” Corporation structure which has been chosen by the Exchange Traded Fund vehicle (NYSEARCA:AMLP) and Funds like MTP is highly relevant.

Master Limited Partnerships (“MLPs”) have been in vogue largely given that tax obligations on their distributions are effectively interest-free loans from Uncle Sam until MLPs are sold. Rather than paying dividend taxes, unit holders step down their cost basis. The asset class has grown in popularity amid today’s yield hungry and uncertain dividend tax environment.

Wall Street is not short on financial engineers or marketing experts. Whether its ETFs, Closed-End Funds, Mutual Funds, or ETNs the product marketers have not been shy in citing whatever original MLP tax advantages their products have managed to retain as they shove “me too” products down the public’s throat.

Seeking Alpha contributor Ron Rowland deserves credit for his work “Beware MLPs in ETF Wrappers”, regardless as to the ETN wrapper’s alternate shortcomings highlighted in the response of AMLP’s distributor. Mr. Rowland has greater respect for the ETN wrapper as an MLP vehicle than do I, but he does have my respect. I applaud his being willing to share the distributors (albeit deflectionary) discrediting of the ETN while continuing his research of AMLP, the ETF.

The simple truth is that the tax efficiency of long term MLP investing is degraded when the underlying units are constituents inside of a wrapper as its own security. The tax efficiency of MLP investing is maximized by perpetual holdings of MLP units. There is no shortage of product and security selection hazards in the MLP space.

An efficient MLP investor typically wants their cost basis to go to zero. An intelligent MLP investor typically wants to maximize the benefit of Uncle Sam’s interest-free loan, and may even use their allocation to MLPs in their estate planning. I frequently use Closed-End Funds and occasionally ETFs or ETNs, but in my view each resembles a leaky can in their effort to retain the tax efficiency of MLPs.

Assuming capital does not flow into a particular “C” Corporation forever, ETF products will be selling units of MLPs at some point in time. Whether Nuveen’s decision was required by Generally Accepted Accounting Principles or not, MTP’s NAV reflecting tax liability prevents MTP from carrying a tax bomb. Specific to MTP, the problem is that this week’s NAV decline for the provision did not provide any ongoing fix to the “C” Corporation election. The ongoing nature is the bigger issue in my view. The $1.05 provision would appear to reflect three years of accumulated tax obligations. MTP had come public in 2007 at $20.

Beyond product engineering that reduces the tax efficiency of investing in the MLP space, what shocks me is that nobody is talking about the portfolio selection . I only recall seeing a products’ print advertisement in Barron’s which observed only one of the space’s hazards in fine print: voting control problems. Personally, I find the governance conflict of interest inherent in Incentive Distribution Rights (“IDRs”) an even greater cause for careful assessment of MLPs. In my view, the long term each conflict of interest to which each MLP is exposed is more relevant than any meager variances among their current yields.

Disclosure: No positions in securities mentioned. My long individual MLP positions and short positions in any MLP products along with my other portfolio and trading activities are licensed as data to Covestor Ltd. (“Covestor”). Covestor is a Registered Investment Advisor that uses my trading data in effort to replicate my actions for its retail investing clients. My individual long MLP positions are licensed to Covestor's MLP Direct Ownership Model. My short position in one MLP focused Closed End Fund is among portfolio data licensed to Covestor’s Long/Short Opportunistic Model. Inquiries relating to Covestor, or originating from Covestor clients and prospective clients must be directed to Covestor Client Services at (877) 873-8830.