Don't let the unfamiliar name fool you. A Master Limited Partnership (MLP) unit is just another kind of publicly traded equity(i.e share of ownership) investment, just like a share of publicly traded common stock. MLPs trade on the major US stock exchanges, so the mechanics of buying and selling them is the same as with any other shares.
More specifically, MLPs are another kind of income-oriented equity. Compared to publicly traded corporations, MLPs are valued more for by the size, stability, and annual growth of their cash flow and distributions.
Traditional MLPs provide exceptionally steady, high yields, and tax advantages that have made them popular with income oriented investors.
The MLP form of organization was created to encourage investment in certain kinds of capital intensive mostly non-renewable, natural resource industries, especially those in the energy sector, by providing a better return to investors than they'd get if they were held in traditional dividend paying corporations.These industries include the exploration, production, gathering, transportation, storage, processing and marketing of mostly non-renewable minerals or other natural resources.
The fundamental differences between MLPs and corporations are in their tax treatment and structure. In the simplest terms, those difference gives MLP investors the advantage of substantially better tax treatment overall returns, and the disadvantage of more complex tax considerations and more limited shareholder rights.
One of the chief reasons income investors like MLPs is that they provide some unique advantages while retaining the most of the simplicity and safety of publicly traded stocks. Like shares in a publicly traded corporation, units in an MLP's ownership trade on the major US stock exchanges, usually the NYSE, sometimes the NASDAQ. That means:
MLPs are subject to the same reporting, accounting, and oversight rules that apply to publicly traded corporations.
MLPs are as easily bought and sold as equities that trade on these exchanges, through the same networks or brokers.
Also, MLPs limit shareholder liability to the value of their investment.
MLPs differ from publicly traded corporations in the following ways. MLPs are:
If you weren't motivated to read this now you should be. The fact is that over the past 10 years (early 2003-2013) the Alerian MLP index, a composite of the 50 leading MLPs, has easily outperformed virtually every comparable publicly traded investment, including REITS, Utilities, the DJIA and S&P 500. Actually, the MLP index has utterly crushed them, and the index both in terms of capital appreciation and yield. Whether you want growth, income, or a combination of the two, none of these has come close to matching MLPs. See Part 2 for further details on why you should be very interested in MLPs.
So as group they provide less opportunity for diversification than standard shares. Looking at how Congress has limited the kinds of activities businesses that be organized and taxed as MLPs, it’s clear that the general goal was to encourage investment and development in non-renewable natural resources (or at least those slow to renew, like timber) of limited supply, and the infrastructure and wholesale marketing needed to deliver them. These activities include their exploration, extraction (typically dug or pumped), transportation or storage from extraction point to wholesale distribution point, wholesale marketing, and certain kind of income from passive investing in these activities or active trading in these. Delivery to retail end users is also allowed but only if by pipeline. Note that this listing is meant to be only a general description of the kinds of activities permitted to MLPs. There are exceptions and relevant details, so those needing these should seek qualified legal advice.
Unlike corporations that are traded on listed exchanges, they are not taxed. All income and deductible expenses pass through the MLP to the owners by way of K-1, a tax reporting form for partnership income. This pass through feature brings both exceptional tax and income advantages, as well as additional tax complexities.
And we'll explain in the following section, because MLPs are pass through entities with exceptionally large non-cash expenses, they are not valued by traditional earnings based metrics, but rather by the size, sustainability, and growth rate of their cash distributions. Their unique suitability for retail income investors has enhanced the focus on their yield.
MLPs are a specific kind of publicly traded partnership and have their own specific ownership structure. We'll cover that in greater depth in Part Three. The key ramification of that organizational difference for investors is that they have far less potential influence over management and thus less ability to protect their own interests.
While there is no federal or state legislative mandate, MLPs are obligated by their partnership agreement or prospectus, as well as by market expectations for MLPs, to distribute most of their available cash, typically 80% or more. MLPs are also structured to give management strong compensation incentives to maximize cash distributions. While they do have considerable leeway in defining "available" cash not needed for ongoing operations and other fixed obligations, they do distribute a far higher percentage of their cash than their corporate counterparts, and unlike most companies, typically depend entirely on external funding sources, the issuance of debt or new equity, for expansion.