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Energy Master Limited Partnerships (MLPs) are a good complement for a fixed income portfolio. They have been one of the best performing asset classes over the last 10 years.
Here are some reasons why you may want to consider adding MLPs to a bond portfolio:
  • Attractive total return
  • Yield: Dividend growth has exceeded the CPI every year for the last 10 years
  • Portfolio diversification
  • Low correlation with other asset classes
  • Tax advantaged
  • Low Beta
  • Resilient business model
I recently attended the 2011 Closed-End Funds and Global ETFs Capital Link Forum where I took in a few interesting sessions on master limited partnerships. Jerry Swank of Swank Capital showed one slide which listed the total return and standard deviation of many different asset classes.
MLPs were the only asset class where the total return was greater than the standard deviation. MLPs have a very high Sharpe ratio and Sortino ratio. These ratios are commonly used to measure risk-adjusted return.
There are several ways to own MLPs. You can buy the individual issues, or purchase closed-end funds, ETFs and ETNs.
There are some tax considerations to take into account when you purchase energy related MLPs. If you directly purchase an MLP, you will receive a K-1, and may be subject to unrelated business taxable income (UBTI). You may also need to file tax returns in several states.
Here are some of the key characteristics of closed-end funds that own MLPs:
1) You will receive one Form 1099 per shareholder instead of multiple K-1 forms.
2) MLP closed-end funds are organized using a C-corp structure, not the usual registered investment company (RIC). CEFs are not structured as RICs because no more than 25% of an RIC can be invested in MLP securities (American Job Creation Act of 2004).
3) MLP CEF dividends are considered qualified dividend income (QDI) and a portion of the dividends are normally classified as return-of-capital.
4) MLP CEF shares do not generate unrelated business taxable income (UBTI) or state taxes in IRAs.
5) MLP CEFs normally use leverage.
6) The standard CEF web sites like cefconnect.com usually report the MLP closed-end funds trading at a premium over net asset value. But this is misleading. The NAV they use is artificially low because deferred tax liabilities (DTL) are subtracted from the NAV because of the C-corp structure. These liabilities are merely unrealized capital gains.
It is best to use an “adjusted” NAV where you add back the deferred tax liability (DTL) to the reported NAV. After this adjustment is made, many of the MLP closed-end funds sell at large discounts to NAV.
Tortoise Energy Infrastructure Corp. (NYSE:TYG) is a closed-end fund designed to provide an efficient vehicle to invest in a portfolio of publicly-traded master limited partnerships and their affiliates in the energy infrastructure sector. It seeks to obtain a high level of total return with an emphasis on paying current distributions to shareholders.
Under normal circumstances, the fund invests at least 90% of total assets in securities of energy infrastructure companies and at least 70% in equity securities of MLPs. Up to 30% of total assets can be in restricted securities, primarily through private placements. The fund may invest up to 25% in debt securities of energy infrastructure companies. This is the sector allocation as of Feb. 28, 2011:
TYG - Sector Allocation Breakdown
Crude/Refined Product Pipelines
40.1%
Natural Gas/Natural Gas Liquid Pipelines
39.7%
Natural Gas Gathering/Processing
14.5%
Propane Distribution
5.3%
Shipping
0.4%
TYG has good long-term NAV performance with the exception of 2008 when it lost 44.6%. Over the last five years, it has produced an 11.84% annualized return. Here is the total return NAV full-year performance for TYG since inception in 2004:
TYG Annual NAV Performance
2005
+4.51%
2006
+35.34%
2007
+7.79%
2008
-44.60%
2009
+82.30%
2010
+32.69%
YTD
-3.09%
TYG- Top 10 Equity Holdings (as of April 30, 2011)
Enterprise Products Partners (NYSE:EPD)
7.9%
Energy Transfer Partners (NYSE:ETP)
7.8%
Enbridge Energy (NYSE:EEP)
7.1%
Kinder Morgan Mgt (NYSE:KMR)
6.1%
Magellan Midstream (NYSE:MMP)
5.8%
Buckeye Partners (NYSE:BPL)
5.0%
Inergy (NRGY)
4.8%
Sunoco Logistics (NYSE:SXL)
4.6%
Oneok (NYSE:OKS)
4.1%
Plains All American (NYSE:PAA)
4.0%
Here are some summary statistics on TYG:
Tortoise Energy Infrastructure Corp.
  • Total assets: 1.60 billion - total common assets: 980.6 million
  • Inception date: Feb. 27, 2004
  • Annual Distribution (Market) Rat e= 5.80%
  • Last Regular Quarterly Distribution = $0.5475 (Annual= $2.19)
(Note: The quarterly dividend was recently raised from $0.5450)
  • Fund Expense Ratio: 1.95% (Management Fee= 0.95%)
  • Discount to NAV = +12.35%
  • Deferred Tax Liability (DTL) = 12.06
  • Adjusted Discount to NAV = -17.50% (add DTL to NAV)
  • Portfolio Turnover Rate: 5.8%
  • Effective Leverage: 24.13%
  • Average Daily Volume (shares) = 70,000
  • Average Dollar Volume = $2.5 million
In 2010, 46% of the dividend was tax deferred. Of course, this is unimportant in an IRA account, but is advantageous in a taxable account. As of the end of April, the CEF asset coverage ratio for debt and preferred was 446% where the minimum requirement is 200%. For debt, the asset coverage ratio was 600%, with a minimum requirement of only 300%.
TYG is reasonably liquid for smaller investments, but care must be used for larger purchases. The official NAV for TYG is only updated weekly by the fund, but estimations of the NAV can be made by looking at price changes in the individual holdings. TYG has had a recent price correction and looks like a reasonable buy at current levels. For liquidity reasons, it seems reasonable to gradually scale in to TYG over a period of time.
Disclosure: I am long TYG.
Source: Tortoise Energy Infrastructure: A Good Way to Invest in MLPs Inside an IRA