US equities have endured a difficult decade, with the S&P 500 posting an average annual gain of less than 5 percent. If you purchased stocks at the height of the tech bubble in 2000 or the credit bubble in 2007–or sold positions in a panic when these bubbles burst–you’re probably nursing considerable losses.

The S&P 500 Energy Index, on the other hand, has returned a whopping 185 percent over the past 10 years, equivalent to an average annual gain of roughly 11 percent. Meanwhile, the Alerian MLP Index, which tracks the 50 largest energy-focused MLPs, is up more than 340 percent over the same period and sports a beta of 0.71.

The Alerian MLP Index has generated market-beating returns with less volatility than the S&P 500.

One stock has outperformed the Alerian MLP Index over the past decade and exhibited even less volatility: units of Kinder Morgan Energy Partners LP (NYSE: KMP), one of North America’s largest pipeline transportation and energy storage companies.

If you had invested $10,000 in Kinder Morgan Energy Partners in late March 2002 and reinvested the quarterly distribution, your position would be worth almost $50,000. In comparison, the same initial investment in the S&P 500 would be worth $15,000 and the same stake in the Alerian MLP Index would be worth $44,000.

At the same time, Kinder Morgan Energy Partners’ stock has a beta of about 0.50; the units don’t fluctuate in price as much as the Alerian MLP Index and exhibit half the volatility of the S&P 500.

Better still, Kinder Morgan Energy Partners’ units offer a distribution yield of 5.65 percent. Over the past five years, the firm has increased its quarterly payout at an average annualized pace of more than 7 percent. The master limited partnership (MLP) has never cut its distribution and raised its payout by almost 20 percent between the end of 2007 and the first quarter of 2010, overcoming plummeting oil and natural gas prices, the worst economic downturn since the Great Depression and a severe credit crunch.

In light of this strength, you’d expect Kinder Morgan Energy Partners and its longtime CEO Richard Kinder to be the darlings of the financial media. The publicly traded partnership has its fair share of admirers, including yours truly–we’ve held the stock in The Energy Strategist’s model Portfolio since the service launched seven years ago. Investors who followed our lead and purchased the stock have been well-rewarded.

Nevertheless, I’ve read innumerable articles over the years that are down on Kinder Morgan Energy Partners and its management team, which is remarkable given the firm’s impressive asset base and the stock’s outperformance.

Negative sentiment toward Kinder Morgan Energy Partners often stems from the firm’s incentive distribution rights (IDR) structure. MLPs consist of two entities: a limited partner (LP) and a general partner (GP), which oversees day-to-day operations and makes major business decisions. Some GPs are publicly traded companies; others are privately held firms.

The best GPs take steps to grow the LP’s distributable cash flow. For example, some GPs will drop down assets to their LP at sale prices that make the deal immediately accretive to cash flow, enabling the limited partner to increase its distribution. The best GPs help their LPs to finance acquisitions, provide direct financial support when business or market conditions and provide solid leadership.

The GP doesn’t perform these functions out of charity. The relationship between GP and LP is governed by the partnership agreement, which also establishes the fees that the LP pays to the GP in exchange for its services. These IDRs are based on the size of the quarterly distribution made to LP unitholders. IDRs are tiered such that the GP gets a larger percentage cut of the cash flow when the LP distribution increases. In other words, the GP’s take only rises when the LP hikes its payout to its unitholders.

Investors must analyze the relationship between the GP and LP before investing in an MLP. Subscribers often ask how much a particular GP is charging LP unitholders to manage the business. To answer this question, you need to understand how a tiered IDR structure works.

Here’s a look at Kinder Morgan Energy Partners’ current IDR structure.

• Tier 1: 98 percent of cash flow goes to holders of Kinder Morgan Energy Partners and 2 percent to the GP, up to a quarterly distribution of $0.15125 per unit.
• Tier 2: 85 percent of cash flow goes to Kinder Morgan Energy Partners and 15 percent to the GP, up to a quarterly distribution of $0.17875 per unit.
• Tier 3: 75 percent of cash flow goes to Kinder Morgan Energy Partners and 25 percent to the GP, up to a quarterly distribution of $0.23375 per unit.
• Tier 4: 50 percent of cash flow goes to KMP and 50 percent to the GP for all quarterly distributions greater than $0.23375 per unit.

In the most recent quarter, Kinder Morgan Energy Partners distributed $1.20 per unit–much more than $0.23375 per quarter. In industry parlance, Kinder Morgan Energy Partners is in the “high splits” with its GP, which is owned by Kinder Morgan Inc (NYSE: KMI). The table below breaks down the payout received by unitholders and the IDR payments collected by Kinder Morgan Inc.

Source: Bloomberg

Many investors don’t understand how IDR payments are calculated. The quarterly distribution declared by the LP each quarter is the amount that investors receive from Kinder Morgan Energy Partners; this payout is only part of the total distribution. To calculate the IDR payment, we begin with the first tier, or all distributions up to $0.15125 per quarter. The first $0.15125 paid to Kinder Morgan Energy Partners’ unitholders represents 98 percent of the total distribution, which means the GP receives slightly less than one-third of a cent.

Repeating this calculation for all the tiers in Kinder Morgan Energy Partners’ IDR structure yields a total distribution of roughly $2.19 per unit, $1.20 of which went to LP unitholders and the remaining $0.99 of which went to the GP. In other words, the LP unitholders received about 55 percent of distributable cash flow, while the GP raked in about 45 percent.

Critics often complain that the GP’s take of Kinder Morgan Energy Partners’ total distribution is excessive. A decade ago, a 50 percent high split was the de facto standard, but many LPs have bought out their GPs in recent years.

Enterprise Products Partners LP (NYSE: EPD), for example, operated under a similar IDR structure until 2002, when the firm became the first major MLP to slash the high-splits take to 25 percent. In 2010 Enterprise Products Partners merged with its general partner, Enterprise GP Holdings, eliminating the IDRs altogether.

An onerous IDR obligation makes it difficult for the LP to grow its distribution. For Kinder Morgan Energy Partners to increase its quarterly distribution to $1.25 per unit from $1.20 per unit, the MLP would need to grow its distributable cash flow by $0.10 per unit to fund the higher LP distribution and the resulting increase to the GP’s IDR payment.

Nevertheless, the bearish case against Kinder Morgan Energy Partners doesn’t hold water. Although the MLP has been in the high splits for some time, the firm has grown its quarterly distribution to LP unitholders at an average annual rate of more than 7 percent over the past five years. This track record surpasses the average rate of distribution growth in the Alerian MLP Index. In fact, Kinder Morgan Energy Partners has increased its LP distribution at a faster pace than Enterprise Products Partners over the past half-decade.

Investors should also consider Kinder Morgan Energy Partners’ future growth prospects. In October 2011, Kinder Morgan Inc announced a deal to acquire pipeline owner El Paso Energy Corp (NYSE: EP) for $37 billion. The acquisition is expected to close in mid-2012. Management has indicated that Kinder Morgan Inc will drop down a number of assets acquired in the deal to Kinder Morgan Energy Partners. These transactions should accelerate the LP’s distribution growth. Management expects Kinder Morgan Energy Partners in 2012 to disburse $4.98 per unit–an 8 percent increase from year-ago levels–while the distribution should grow at an annualized rate of 5 percent to 7 percent over the next two years.

If these forecasts come to fruition, Kinder Morgan Energy Partners’ distribution growth rate would rank toward the top of its large-capitalization peers–so much for the high splits being an impediment.

Criticism of CEO Richard Kinder is even less justified in my view. Pundits who claim that Kinder has profited at the expense of unitholders should examine the facts. Like Enterprise Products Partners’ late founder Dan Duncan, Richard Kinder has been at the leading edge of developments in the midstream energy business.

In 1996 Kinder appeared to be first in line for the CEO job at Enron, but ultimately lost out to his colleague Kenneth Lay. Whereas Kinder saw the value in energy infrastructure such as pipelines and storage facilities, Lay’s focus on asset-light trading operations won out. Today, Kinder is a billionaire, while many of his fellow managers at Enron lost their personal fortunes in the company’s collapse or ended up in prison.

In the ensuing years, Kinder Morgan Energy Partners has amassed an enviable portfolio of pipelines and other midstream assets, many of which generate cash flow guaranteed by long-term contracts.

Another hallmark of a great CEO and manager is the ability to weather and thrive during a downturn as traumatic as the 2008-09 credit crunch and Great Recession. Those questioning Kinder’s acumen or compensation should consider this excerpt from Kinder Morgan Energy Partners’ conference call to discuss results from the third quarter of 2008:

Now, the 500 pound gorilla in the room is obviously the volatility in the capital markets. Let me just address that ahead on. I think it’s worth discussing how we expect to fund our expansion projects. Several factors here, the first and most important factor is the strength of our existing assets and our expansions. Our diverse set of energy infrastructure assets will generate about $2 billion of cash flow that can be distributed to our partners in 2008. We expect that number to increase in 2009. And let me be clear, that $2 billion is after all operating expenses, debt service, and sustaining capital expenditures. That’s a very important factor in the strength of our capital structure.

Number two, our expansion projects in aggregate will generate attractive returns on our investments using conservative projections secured by contracted customer commitments even after the cost overruns we talked about.

Third, we have ample access to short-term funds through unused capacity at our credit facilities. Let me talk about those. At year-end, even if we don’t put out any additional capital between now and year-end, we will still have undrawn capacity on our KMP line of well over $600 million on 12/31/2008, and we will have substantial amounts on our JV credit facilities. At REX, we expect to have well over $500 million and at Midcontinent Express well over $200 million of undrawn capacity at year-end without raising any additional capital, equity or debt, between now and year-end.

Our common units, KMR shares, and debt have performed relatively well, although I’m reminded of that old saying: in the land of the blind, the one-eyed man is king. But they performed relatively well compared to our peer group over these last several months. That’s allowed us to raise $3.4 billion of long-term debt over the last 15 months, and $843 million of equity over that period of time. Now if you include the KMR distributions, which is essentially an automatic distribution reinvestment program, we’ve raised approximately 1.2 billion of equity over that same 15 months. That gives us lot of confidence that we’ll be able to access these markets to raise new capital.

But fourth, in addition, our general partner, Knight Inc., the general partner of KMP, has substantial financial resources. This year, Knight will have EBITDA [earnings before interest, tax, depreciation and amortization] of over $1 billion for calendar year 2008 and we have a debt to EBITDA ratio of about 2.6. We’re prepared to use those financial resources if necessary, and the Board of Directors of Knight today indicated its willingness to contribute up to $750 million to purchase equity from KMP over the next 18 months, if necessary to support KMP’s capital raising efforts.

In late 2008, even AAA-rated companies struggled to borrow money because the capital markets had frozen over. But Kinder Morgan Energy Partners was set up to fund most of its required capital expenditures from internally generated funds.

In the final paragraph of this excerpt, Richard Kinder notes that Kinder Morgan Energy Partners’ GP–then a privately-held company that he controlled–offered to support the LP with a capital infusion of up to $750 million via an equity purchase. How many other CEOs stepped up to the plate like that in those dark days?

There’s an old Wall Street saw that the bearish case always seems smarter than the bullish case–but that doesn’t necessarily mean the bears are correct. This wisdom also applies to financial journalism: A story purporting to unveil how a company is overcharging its investors will undoubtedly attract more attention than a piece explaining how a firm has generated substantial wealth for investors.

Investors who avoid Kinder Morgan Energy Partners are being penny wise and pound foolish. Although the MLP’s IDR obligations may exceed those of its peers, the firm’s long-term performance and future growth prospects overshadow this concern.

In the end, Kinder Morgan Energy Partners’ distribution growth and the stock’s price appreciation speak more loudly than an army of scribblers and talking heads.

Around the Portfolios

First-quarter earnings season is under way. Here are the confirmed and estimated reporting dates for our Portfolio holdings. All dates marked with an asterisk are estimated.

Growth Portfolio

Baker Hughes (NYSE: BHI)–04/24/12
BG Group (LSE: BG/, OTC: BRGYY)–05/03/12
Cameron International (NYSE: CAM)–04/26/12
Chesapeake Granite Wash Trust (NYSE: CHKR)–N/A
Core Laboratories (NYSE: CLB)–04/19/12
Dresser-Rand Group (NYSE: DRC)–04/27/12
Eagle Rock Energy Partners LP (NSDQ: EROC)–05/02/12
Ensco (NYSE: ESV)–05/03/12
EOG Resources (NYSE: EOG)–05/09/12
Linn Energy LLC (NSDQ: LINE)–04/26/12
Mid-Con Energy Partners LP (NSDQ: MCEP)–06/06/12*
Nordic American Tanker Shipping (NYSE: NAT)–05/09/12
Occidental Petroleum Corp (NYSE: OXY)–04/26/12
Peabody Energy Corp (NYSE: BTU)–04/19/12
Petrobras (NYSE: PBR A)–05/14/12*
SandRidge Mississippian Trust I (NYSE: SDT)–N/A
SandRidge Mississippian Trust II (NYSE: SDR)–N/A
SandRidge Permian Trust (NYSE: PER)–N/A
Schlumberger (NYSE: SLB)–04/20/12
Suncor Energy (TSX: SU, NYSE: SU)–04/30/12
Weatherford International (NYSE: WFT)–04/24/12
World Fuel Services (NYSE: INT)–05/01/12

Conservative Portfolio

Chevron Corp (NYSE: CVX)–04/27/12
Eni (Milan: ENI, NYSE: E)–04/27/12
Enterprise Products Partners LP (NYSE: EPD)–05/02/12
Kinder Morgan Energy Partners LP (NYSE: KMP)–04/18/12
Natural Resource Partners LP (NYSE: NRP)–05/04/12*
NuStar Energy LP (NYSE: NS)–04/25/12
Penn Virginia Resource Partners LP (NYSE: PVR)–04/27/12
Sunoco Logistics Partners LP (NYSE: SXL)–05/02/12
Teekay LNG Partners LP (NYSE: TGP)–05/18/12
Total (Paris: FP, NYSE: TOT)–04/27/12

Aggressive Portfolio

Afren (LSE: AFR)–05/18/12*
Alliance GP Holdings LP (NSDQ: AHGP)–04/30/12
GasLog (NYSE: GLOG)–N/A
Nabors Industries (NYSE: NVR)–04/24/12
Oasis Petroleum (NYSE: OAS)–05/11/12
Pacific Drilling (NYSE: PACD)–N/A
Petroleum Geo-Services (Oslo: PGS, OTC: PGSVY)–05/08/12
SeaDrill (NYSE: SDRL)–05/31/12
Tenaris (NYSE: TS)–04/26/12