Financial system reform has taken a back seat to health care in the Obama administration’s first nine months. This won’t last forever. And that has profoundly unfortunate implications for investors in one group of master limited partnerships (MLP): investment partnerships.

We’ve addressed this issue in several presentations to investors over the past year, most recently in San Francisco. At the root is the concept of “carried interest.” The specifics are a rather arcane matter. But suffice to say the effect is that hedge funds and private equity firms can pay their partners carried interest distributions that are taxed as capital gains.

The result is partnerships that own a collection of bank stocks, for example, get the same tax benefit as those that own pipelines, and can therefore pay big dividends as well.

MLPs first emerged in the 1970s and ’80s as a way to securitize financing for real estate firms and were soon adopted for similar reasons by a range of industries, including the energy industry.

By the 1980s, however, they were being used as a tax dodge by numerous companies in far more cyclical industries. The result was a great sector implosion, as economic pressures forced the pretenders off the face of the earth.

Predictably, the US government got involved in the game after the damage had already been done, and the response was typically draconian. The Tax Reform Act of 1986 and the Revenue Act of 1987 basically eliminated preferential tax treatment for all MLPs except those involved in “natural resource” activities such as oil and gas exploration, production, processing and transportation. The remaining companies that weren’t bankrupt converted to real estate investment trusts or ordinary corporations under a 10-year phase-out.

That’s the way things stood up until this decade, when high-yield investing again became wildly popular. In response to Wall Street’s desires, Congress and the Bush administration began to relax the rules on MLPs once more, finally removing most rules governing institutional ownership. The result has been a more than doubling of the ranks of MLPs (see How They Rate) since the ’90s.

The best of the new MLPs are spun-off units of major energy companies, holding their parents’ best and most reliable cash-generating assets. And we hold several in the MLP Profits Portfolio, including Conservative Holding Spectra Energy Partners LP (NYSE: SEP) and Aggressive Holdings EV Energy Partners LP (NSDQ: EVEP) and Williams Partners LP (NYSE: WPZ).

These have been far outnumbered, however, by a tidal wave of offerings of investment MLPs, whose parents used the carried interest loophole to grab the same tax advantages. The Blackstone Group LP’s (NYSE: BX) offerings were the most notorious of private-equity firms going MLP as a way to beat the taxman. But their ranks include several other very popular MLPs, such AllianceBernstein LP (NYSE: AB), which now has a market capitalization of $2.63 billion.

The fact that investment MLPs are entirely different animals than energy-related MLPs hasn’t been lost on Congress. Last year, at the same time Washington was extending the benefits of energy MLPs, the House of Representatives passed legislation that would have taxed carried interest as ordinary income. That, in turn, would have dramatically reduced cash flow available for investment MLPs to pay distributions. And the almost certain result would have been a mass wave of dividend cuts and an accompanying selloff of the group

That bill was eventually defeated in the US Senate. But it’s been resurrected again this year as a part of the Obama administration’s proposed 2010 budget. And with financial reform gaining traction in Washington, it has at least a high probability of coming up again in major legislation, if for no other reason than to raise additional revenue.

The most significant recent development on the financial reform front is a budding alliance between Senator Mark Warner (D-VA) and Senator Bob Corker (R-TN). Both are outranked in the Senate Banking Committee. But in a year of partisan rancor, their centrist approach is the kind of push that reliably gets stalled bills moving. And that’s bad news for MLPs relying on carried interest to pay their distributions.

The good news for all MLP Profits recommendations: They don’t rely on carried interest for a single penny of income. As a result, they’re not at risk. In fact, should Congress kill off investment MLPs, they could well benefit.

Many investors have effectively become yield chasers in a desperate quest to make back what they lost over the past couple of years. They’re chasing the highest numbers, paying little or no attention to what makes paying that high yield possible. As far as MLP Profits recommendations are concerned, eliminating investment MLPs would deep-six a competing investment vehicle.

How likely is Congress to act on carried interest? Only time will tell. But if you own any investment MLPs, now’s the time to sell. AllianceBernstein, for example, is trading close to a new 52-week high and it yields less than 6 percent. That’s ridiculously little for an investment clearly in Obama’s sights.

In contrast, our five Growth Portfolio MLPs derive their income from operating businesses with no carried interest. DCP Midstream Partners LP (NYSE: DPM) yields 9.4 percent, Energy Transfer Partners LP (NYSE: ETP) yields 8.3 percent, Inergy LP (NSDQ: NRGY) yields 8.7 percent, Kayne Anderson Energy Total Return Fund (NYSE: KYE) yields 9 percent and Teekay LNG Partners LP (NYSE: TGP) yields 8.9 percent.

That’s an average of 8.9 percent–or 3 percentage points more than AllianceBernstein. All five held their own during the credit crunch and subsequent recession, with several actually raising distributions. That’s in stark contrast to AllianceBernsten, which plunged from a mid-2007 high of over $90 a share to a low of barely $10 earlier this year.

Finally, all five are infinitely better prepared for what’s likely to be income investors’ next big challenge: a possible return of inflation fueled by higher commodity prices.

As we’ve pointed out in past articles, at the Growth Holdings’ core are fee-generating infrastructure assets. These proved their mettle in the recession, continuing to generate robust cash flows that covered distributions, maintained expansion plans and kept balance sheets healthy. That offset weakness in the commodity price-affected segments of their businesses, which were heavily impacted especially by falling natural gas prices.

Now, with natural gas prices moving higher once more, returns from these operations are also improving. The result has been a gradual upward push for this group, including the relative laggard Energy Transfer Partners, as profits from gas gathering, processing and other commodity price-sensitive enterprises has begun to swell once more.

Source: Bloomberg

Looking ahead to the rest of the year, natural gas is again entering a period of seasonal strength. There are still headwinds, mainly the weakness of the North American economy and still overflowing inventories in storage.

As is always the case, much will depend on weather and mild temperatures would almost certainly send prices lower. On the other hand, however, natural gas production has fallen sharply in North America, and the potential surprises all seem to be on the upside, from the weather to a faster-than-expected recovery in industrial demand for gas.

The result could well be an upside surprise for gas, which would help all of these MLPs immensely. That includes Kayne Anderson, which is actually a closed-end fund holding both energy infrastructure and energy producing MLPs.

Looking further out, the future for North American natural gas seems to be in exports to the rest of the world. As of yet the primary LNG infrastructure is geared for imports, which have understandably avoided this country due to low prices. That’s one reason we continue to rate Cheniere Energy (NYSE: LNG) a sell, as weak LNG traffic has left its business in a very bad way.

It’s possible Cheniere will be able to make the investment at its facilities so it can export LNG as well as import it. But whoever does the job, it looks like LNG will indeed begin flowing the other way–to Asia and Europe where gas prices are considerably higher–in the coming years. That, in turn, will revive the business and gas prices, and all of our Growth Holdings will benefit.

Over the next several weeks we’ll get the next installment of their earnings. We’ll have a full recap in the next Growth Holdings article. Here are the scheduled and estimated dates for the numbers of all MLP Profits Portfolio holdings.

Conservative Holdings

• Enterprise Products Partners LP (NYSE: EPD)–October 26*
• Genesis Energy LP (NYSE: GEL)–November 6*
• Kinder Morgan Energy Partners LP (NYSE: KMP)–October 21
• Magellan Midstream Partners LP (NYSE: MMP)–November 3
• Spectra Energy Partners LP (NYSE: SEP)–November 6*
• Sunoco Logistics Partners LP (NYSE: SXL)–October 22*

*Bloomberg estimate

Growth Holdings

• DCP Midstream Partners LP (NYSE: DPM)–November 6*
• Energy Transfer Partners LP (NYSE: ETP)–November 10*
• Inergy LP (NSDQ: NRGY)–November 4*
• Teekay LNG Partners LP (NYSE: TGP)–November 3*

*Bloomberg estimate

Aggressive Holdings

• EV Energy Partners LP (NSDQ: EVEP)–November 11*
• Legacy Reserves LP (NSDQ: LGCY)–November 5*
• Linn Energy (NSDQ: LINE)–November 6*
• Navios Maritime Partners LP (NYSE: NMM)–November 19*
• Regency Energy Partners LP (NSDQ: RGNC)–November 10*
• Williams Partners LP (NYSE: WPZ)–November 6*