master limited partnerships by PastorGallo


More Info
									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.

To top