Investors seeking exposure to master limited partnerships (MLPs) have many options. There are of course conventional energy MLPs, ranging from upstream (oil and gas producers) to midstream (logistics) and downstream (refiners). MLPs also offer niche opportunities in sectors as diverse as marine shipping and propane distribution. Further afield, the MLP structure is popular with private equity shops and also used to invest in forestry, amusement parks and fertilizer production.

There are MLPs that are structured as partnerships, but have chosen to be taxed as corporations. This class will be covered in an upcoming issue. The main advantage for investors is that this structure somewhat simplifies tax reporting, while offering the attractive yields of an MLP.

Mutual funds are another way to play the MLP space in a way that simplifies tax reporting. But because these mutual funds must pay corporate income tax on their earnings, most of the tax advantage of directly investing in MLPs is lost. Many of the funds use leverage to help overcome some of this disadvantage, but this can be a risky strategy and one that adds to costs.

Nevertheless, at times the MLP-focused mutual funds may be attractive. Consider a closed-end fund (CEF). These funds trade on an exchange just like a stock or MLP unit, which means that the underlying value of the securities held by the fund can become disconnected from the price of the fund share. Some days the market capitalization of the fund is valued at more than the underlying securities (i.e., it trades at a premium) and other times the fund is valued at less than the securities it holds (i.e., it trades at a discount).

A good source of information on MLP closed-end funds is MLPData.com. The following table shows the premium/discount for the MLP CEFs.


Closed-end MLP funds. Data Source: MLPData.com

As I write this, Tortoise Pipeline and Energy (NYSE: TTP) trades at a discount of 15.1 percent to its underlying assets, while at the other end of the spectrum Cushing MLP Total Return Fund (NYSE: SRV) trades at a 17.4 percent premium. The average MLP closed-end fund listed trades at a 4.9 percent discount, which is perhaps reasonable given the loss of certain tax advantages and the fact that management fees will eat into returns.

Of course most of us like the idea of buying things for less than their inherent value. This is why Black Friday is such a popular event every year. But closed-end funds sometimes trade at a premium or discount for a good reason.

Perhaps management doesn’t have a consistent track record. Or maybe market sentiment has turned against a particular group of MLPs (say, upstream ones) within a fund’s portfolio. In that case, though, investors exiting a fund could discount it excessively relative to its losses on unpopular holdings.

This volatility can create opportunities for patient investors. Over time, a well-managed closed-end fund with reasonable management fees shouldn’t sustain a large discount. So investors interested in this space should watch the premium/discount of CEFs. A fund may be of interest if its discount widens well beyond historical norms.

As for Tortoise Pipeline and Energy, it’s a two-year-old fund offered by a respected MLP asset manager, with the bulk of its portfolio in midstream energy infrastructure, mostly such corporate MLP sponsors as Spectra Energy (NYSE: SE) and Williams (NYSE: WMB). Traditional MLPs make up the 25 percent maximum of the portfolio permitted by law, and oil and gas producing corporations account for another 15 percent.

Net asset value increased 33.3 percent last year, while the unit price rose just 23.7 percent, helping to boost the NAV discount to its current levels. The current yield is 5.8 percent, but another useful site for closed-end funds, Nuveen’s CEFConnect.com, puts the total annual expense ratio at a hefty 3.4 percent. (Tortoise’s own site lists the management fee at 0.95 percent, excluding other expenses.) And unlike much of the traditional MLP distribution, TTP’s quarterly payouts are mostly not tax deferred, unless held in a tax-deferred IRA account.    

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)

Portfolio Update

Boardwalk Craters

This is, fortunately, an update not on a current portfolio holding but rather one on Boardwalk Pipeline Partners (NYSE: BWP), the MLP we recommended selling in November at near $28 and ahead of a continuing decline that cost investors another 13 percent as of Friday.

By last fall, it was already clear that the development of the Marcellus shale had undermined the long-term profitability of Boardwalk’s Texas-to-Northeast pipelines, and that the balance sheet was too stretched to absorb a protracted business downturn.

But no one could have anticipated today’s announcement that the distribution would be slashed by 80 percent in response to an anticipated 30 percent decline in distributable cash flow. Not only are expiring gas shipping contracts not getting renewed at anything like the former rates, but the narrowing of regional differentials on natural gas has undermined the fundamentals of Boardwalk’s gas storage business. On top of that, last year’s cash flow was boosted by gas sales that won’t repeat.

Boardwalk’s unit price plunged 46 percent in a single day on the news, all the way to $13.01. It’s only the latest reminder of the folly of comparing MLP distributions with bond yields, which cannot be unilaterally lowered by a board. MLPs are dynamic, often volatile businesses, and the cost of changing market conditions and excessive leverage can be drastic. There is no free lunch and no extra yield without extra risk. Our goal is to protect your portfolio from the next Boardwalk.

— Igor Greenwald

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