November 13, 2006 MASTER LIMITED PARTNERSHIPS No. 1 Master Limited Partnerships trade like minus the lowered cost basis) is treated stocks but act more like fixed income as a capital gain, and a portion is taxed securities with tax advantages. Though as ordinary income. MLPs are not they trade on exchanges like the New suitable for tax-deferred accounts such as York Stock Exchange, Master Limited IRAs because earnings above $1,000 are Partnerships (MLPs) trade as units, not considered “unrelated business income,” shares. They currently pay income at which is taxable. annual rates of 6.5% to 7.5%. As with any high-yielding instrument, the Unlike bonds, payments may rise if the attraction of the yield paid by MLPs dips company grows. And the price of units as interest rates rise. A 7% MLP dividend could rise. But both of these come with looks better to investors when bonds are the risk that income or unit price could paying 4% than when fixed income is drop if the company runs into trouble. paying 5.5%. Interest rate rises can cause MLP unit prices to fall versus other Many portfolios see diversification shares. Some MLPs operate in industries benefits from MLPs. Some MLPs that such as gas pipelines where transmission passed our screen of certain criteria carry rates adjust for inflation. So if interest a beta of -0.1 to +0.4. The stock market, rates rise with inflation, chances are represented by the S&P 500 index, has a dividends paid by the MLP also will rise, beta of 1.0. The more a security’s beta protecting the units from the price effect diverges from the market’s, the greater you would expect when other rates rise. the diversification benefits. That should translate into lower risk and/or higher Key factors to look for when deciding on returns for a portfolio. MLPs to buy include: Distribution coverage. Is the company Because MLPs throw off partnership generating enough cash flow to cover its losses, holders of MLP units typically can promised payout? Look for a distribution defer taxes on much of the yield they ratio above 1.0. receive. Holders need to file a tax form K- Current payout level. MLPs carry more 1 to capture the details of the partnership risk than Treasuries. They should have income and losses. yields well above Treasury yields. Growth in payout. Dividend history will tell Investors often want to have these you whether the income has grown. investments in their taxable accounts Debt-capital ratio. If an MLP is deep in because of tax advantages that accrue debt, it might not be able to maintain from MLPs. If an investor reaps tax payout if business hits a bump. benefits from an MLP, selling the units can generate taxes in the year of the We believe MLPs offer diversification, sale. Over time, the income payments income and appreciation potential. If you reduce the cost basis of the investment. would like to discuss them in relation to When the units are sold, a portion of the your account with us, please call at your gain (the difference of the selling price convenience.
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