Why Buy MLPs? Part II

Since my article on MLPs, published just a few days ago, they have fallen to new lows. Let me comment.

My interest began last year because of the high yields (at that time around 6%) along with their track record of growth. The Alerian MLP index was completing 9 month of gains from 250 to about 330. (I felt frustrated wishing I had purchased before the run-up.) The trend flattened out for a few months, peaking at 342 then fell off a cliff when it nosedived to a low of 282 in only 3 weeks (July-August). Since then it has been slipping and sliding. First above 300, then into the 290s, then 280s and more recently kicking around the 260s which brought it back to starting level for the bull run. Monday it fell to a low, 236, over 100 points below the peak.

Fundamentals for MLPs remain in place. They keep building more pipelines and adding to their capital base to keep the tax shelter for distributions paid. Demand to use pipelines remains strong. With the index sliding downward, the immediate road ahead probably will be bumpy (i.e. expect more down bumps than up bumps). But the high yields will help ease the waiting period until markets recognize true value.

The key to fundamental values is the track record for the Alerian MLP index. It began with a value of 100 at the start of 1996. Even after allowing for the pullback starting the last year, the index has done well. The current yield, based on its lower price, is almost 9% or about 550 basis points above the Treasury bond rate. With reinvested income, the annual compounded growth rate has been 14%. Few investments can match this record, especially after the bear market at the start of this decade.

MLP index

Jan 1, 1996..........100

Sep 15, 2008.......236

Sep 15, 2008.......565 with reinvested income

After Monday's (Sep 15) massive sell-off, long term track records are more important when choosing investments. High levels of dividends to reinvest are key in today's troubled times. I just wrote another article (published September 15) on high yield (junk) bond funds. They got slammed very hard on Monday, along with other investments related to debts, sending yields above 13%. The excessive selling was undeserved. I'm working on another article about REITs, with pretty much the same story, high yields coupled with good track records which have produced excellent gains over the years.

The S&P 500 Dividend Aristocrats are another good source for quality investments. These companies (59 at last count) are members of the S&P 500 with a minimum of 25 consecutive years of higher dividends. Last year Exxon Mobil (XOM) finally was able to join. Even with the tough standard, a few are dropped and a few others are added each year. Careful analysis is always necessary for very smart investing.

The Wall Street Meltdown created a cloud of pessimism. New rules for lending are being made up on the fly. High yields from dividends and distributions are increasingly important. Diversification is a term that is coming back, particularly after today's sell-off. The concept remains good. MLPs, high yields bond funds, REITs and members of the S&P 500 Dividend Aristocrats should be main ingredients in portfolios for very smart investing.

Stock position: None.

Comments

[Augustus:]

BSR is the tracker, I believe. It also solves the tax filing problem of holding the MLPs

2008 Sep 17 09:41 AM

[Internet2k4:]

Thanks for the steer to BSR - on lookup I note it's a McGraw-Hill ETN (with a pretty steep .85% ER), so these days there'd be issuer credit risk apart from the market. There are risks as well as benefits to not owning the underlying assets.

2008 Sep 17 10:09 AM

[epeon:]

MRLPs are not just pipelines. For example, ARLP is a coal MRLP. It, too, has been crushed. Hard to really understand why. It is not a financial instrument. Rather, it is the most basic of industrial commodities. I mean, we burn coal for electricity and we will still burn coal after the financial meltdown. Yet, the stock has been crushed. I think this is an over-reaction and it is a great buy here. but, hey, what do I know?

2008 Sep 17 12:01 PM

[resourceman:]

Avi, I went back and read your first bit on MLP,s and make the following comments: in the list of MLP,s you have Linn Energy LLC UTS posted. This is not a MLP--it is an Oil & Gas Royalty Trust which has a still different tax treatment--unit holders receive a 1099-Royalty & can deduct depletion allowance & taxes. If you,re including Royalty Trusts in your analysis , there are much better ones out there. Linn Energy did particularly poor on their 2Q earnings--they lost $773,400,000 on their O / G commodity hedges--I,ve stayed away from them also because they,re royalty assets are in states that tax royalty income. Two Trusts I recommend are BPT ( B P Prudhoe Bay Roy Tr. ) & PBT ( Permian Basin Roy Tr. ) . PBT has all of it,s royalty interests in the state of Texas which has no income tax & does not tax royalty trust income. I,ve got some royalty interests in New Mexico & they,re killing me with Taxes ~8% off the top. When investing in O/G Roy Trusts one must consider which states the royalty interest is in. Whereas pipeline & terminal type MLP.s are basically toll-takers & their distributions are more stable , the drawback with Roy Trusts is their payments do track the price of the commodity . But on average , Roy Trusts today pay about twice the yield that MLP,s do. Could say you,re being compensated for the added risk of commodity price changes.

2008 Sep 17 05:18 PM

[richandmer:]

BSR (Bears Stearns . .) was mentioned as the ETN tracker. It appears that the latest distribution is not listed in Yahoo Finance. Since Bears Stearns is involved, is it possible that the distribution was stopped?

2008 Sep 17 06:33 PM

[slsdoug:]

AMZ also tracks the Alerian index.

2008 Sep 17 09:18 PM

[sante06:]

Can you set up DRIPS through MLPs? Does KMP have a DRIP?

2008 Nov 17 10:27 PM