Master Limited Partnerships (MLPs) have been popular investments for income portfolios for the past couple decades, but over the past year there has been a noticeable push to promote these investments to a greater number of individual investors. Everyone from Jim Cramer to Barron’s to the Motley Fool seem to have concluded that owning partnership units are the closest thing to a perfect investment as one can make for an income portfolio. But are these investments too good to be true?
The basics of MLPs are explained pretty well at Investopedia and others websites. The MLP world consists primarily of groups engaged in natural resource activities, notably oil and gas pipeline operations. Because of the way they are structured and the tax-favored treatment they receive, MLPs are able to offer investors attractive high-yield returns. Unlike regular dividends, the distributions from MLPs are treated as a combination of income and return of capital. Many investors (myself included) are turned off by the paperwork and recordkeeping needed for tax purposes. Partnerships are considered pass-through entities, so, as a unitholder, you are obligated to pay your share of the taxes for a partnership’s income. Instead of 1099s, you would receive K-1 forms annually for your holdings. The recordkeeping becomes even more involved if you hold these investments in a retirement account. Understand the tax implications before investing in these entities.
MLPs have bounced back nicely from the 2008 debacle, and earlier this month they actually looked overpriced. Over the past week though (I’m writing this in late-May 2013), there has been a significant correction in the sector, so prices appear a little more palatable. As with any high-yielding investment, these investments are sensitive to interest rate changes, so I would advise watching these investments closely going forward.
One way to bypass the tax headaches for these investments would be to invest in an MLP fund or ETF like AMLP or EMLP. Before investing, I would run the numbers to make sure the fund expenses and fees are worth the return and income you are seeking. If they are, then these may be smart investments for your income portfolio.