APR. 24, 2013
INVESTOR EDUCATION
GLOBAL INVESTMENT COMMITTEE
Asset Class Review
OVERVIEW
AUTHOR
Master Limited Partnerships
DAVID M . DARST , CFA
DESCRIPTION. Master limited partnerships (MLPs)
operate physical assets such as pipelines, tank facilities, and other equipment for oil, natural gas,
natural gas liquids, and refined products processing, fractionation, transportation, and storage
services. MLPs are partnerships (or LLCs(1))
listed on public exchanges. MLPs trade in the
form of units and unitholders receive quarterly
cash distributions. Structured as pass-through
entities, MLPs pay no entity-level tax; instead,
taxes are paid by unitholders on distributions,
based on the unitholder’s specific tax rate with a
portion of the taxes paid on a deferred basis.
The first MLP was launched in 1981, as the
Apache Oil Company. As of early 2013, total MLP
market capitalization exceeded $480 billion. In
1987, as MLP structures began to proliferate
through a variety of industries (including sports
teams such as the Boston Celtics), the US Congress created Section 7704 of the Internal Revenue Service Tax Code to limit partnership tax
treatment to MLPs earning at least 90% of their
income from qualified sources. Qualified sources
include interest, dividends, capital gains, natural
resources activities, and rental income; capital
gains from real estate; income from commodity
investments; and capital gains from the sale of assets used to generate such income. Qualifying
natural resources include oil, gas, and petroleum
products; coal and other minerals; timber; any
other resource that is depletable under section
613 of the US Tax Code; and since 2008, industrial
carbon dioxide, ethanol, biodiesel, and other alternative fuels.
The most common structure for an MLP consists
of a general partner (GP) and limited partners
(LP). The GP manages the daily operations of the
partnerships, generally has a ~2% ownership
stake, and may have incentive distribution rights
(IDRs). As unitholders, the LPs have no role in
the partnerships’ operations or management.
CHOICES.
Master limited partnerships are available in several formats. Investors can directly invest in MLPs by purchasing units on a major securities exchange. Other options include: (i)
closed-end MLP mutual funds; (ii) open-end
MLP mutual funds; (iii) exchange traded notes;
(iv) exchange traded funds; and (v) i-shares. Ishares are shares of a publicly traded management company whose only assets are the underlying MLPs and whose distributions are in the form
of additional i-shares instead of cash. Certain
MLP-dedicated open-end and closed-end mutual
funds and exchange traded funds may offer exposure to MLP investments without incurring unrelated business taxable income (UBTI) and without the need to file state filings and/or a federal
IRS K-1 partnership return.
Chief Investment
Strategist
212-296-6224
David.Darst@ms.com
Master Limited Partnerships
Advantages
Disadvantages
1. Due to their relatively predictable pattern of income generation and quarterly distributions, several segments of the
MLP asset class tend to possess important defensive characteristics within a portfolio context.
1.
MLPs are usually dependent on access to debt and equity capital markets to fund growth in assets, and thus growth in distributions. Financial market developments that might restrict such access could negatively affect distribution growth.
MLPs offer portfolio diversification benefits through generally low returns correlations with equities, underlying commodity prices, and 10-year US Treasury securities.
When directly investing in MLPs, investors receive a schedule
K-1 instead of a form 1099-DIV. Additionally, investing in MLPs
through tax-exempt vehicles can be problematic since MLPs tend
to generate unrelated business taxable income (UBTI). Limited
Partners (unitholders) usually have very little or no control over the
management and operation of an MLP. Investing in MLPs differs
from investments in common stock, with risks related to cash flow,
dilution and voting rights.
3. The potential for MLP quarterly distributions to increase
over time may represent a growth opportunity and a partial
hedge against inflation. From 1995 through 2011, MLP total returns have outperformed those of the S&P 500. Past investment
performance is no guarantee of future investment results.
3. Incentive distribution rights (IDRs) may be structured into
many MLPs to incentivize the general partner (GP) to increase the
amount of the quarterly distributions; however, the nature of the incentive may motivate the general partner to increase distributions
as quickly as possible as opposed to increasing the distributions at a
rate which maximizes the value of the MLP for limited partners as
well as the general partner.
MLPs may offer tax advantages through the partnership
structure as well as due to the partially deferred taxes (generally
around 80%) applicable to the quarterly cash distributions received by unitholders, both of which serve to enhance investor
total return.
Correlations of returns for MLPs with the returns on other asset classes may: (i) vary over time; and (ii) change in an adverse way
during periods of financial market turbulence. Energy infrastructure companies are subject to risks specific to the industry such as
fluctuations in commodity prices, reduced volumes of natural gas or
other energy commodities, changes in the economy or the regulatory environment, or extreme weather. Some MLPs may trade less
frequently than larger companies due to their smaller capitalizations which may result in erratic price movement or difficulty in
buying or selling.
5. MLPs may offer estate-planning benefits as the cost basis of
MLP units is stepped up to fair market value when, upon the
demise of the owner, units are transferred to beneficiaries. In
general, this tends to negate the accumulated tax deferred liability from past distributions.
5. While MLPs have been granted partnership taxation treatment
in order to foster investment in the US energy infrastructure, MLPs’
tax status may be subject to revision by Congress. MLPs are subject
to significant regulation and may be adversely affected by changes
in the regulatory environment, including the risk that an MLP
could lose its tax status as a partnership, which could reduce the
value and income produced from the MLP.
2.
4.
2.
4.
Source: National Association of Publicly Traded Partnerships (naptp.org); Morgan Stanley Wealth Management Global Investment Committee; Morgan
Stanley & Co. Research “Midstream Energy MLPs Primer 3.0, April 18, 2013,” (67 pages), by Stephen J. Maresca, Robert S. Kad, Shaan Sheikh, and Brian Lasky.
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MORGAN STANLEY WEALTH MANAGEMENT | APR. 24, 2013
Please refer to important information, disclosures and qualifications at the end of this material.
Alerian MLP Index – Price Performance
Price Performance From Inception on December 29, 1995 to 2013 YTD
(Price in US Dollars)
(1)
500
450
400
350
300
250
200
150
100
50
0
(1)
1995
1996
1997
1998
200
2001
200
200
200
200
200
200
200
200
2010
2011
2012
2013
Note: (1) Data are as of Apr. 19, 2013.
Source: Bloomberg.
Alerian MLP Index – Sector Composition
As of Year-End 2012
Exploration & Production
6.7%
Other
5.4%
Petroleum Transportation
36.8%
Natural Gas
Transportation
33.6%
Propane
2.2%
Gathering and Processing
15.3%
Source: Alerian Capital Management, Dallas Texas.
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MORGAN STANLEY WEALTH MANAGEMENT | APR. 24, 2013
Please refer to important information, disclosures and qualifications at the end of this material.
Alerian MLP Index – Monthly and Annual Total Returns
(% in US Dollars)
(1)
From Inception in December29, 1995 to 2013YTD
YEAR
JAN
FEB
MAR
APR
MAY
JUN
JUL
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
12.62
1.94
3.02
0.63
15.25
-0.59
4.98
5.54
5.06
-1.35
4.47
-0.74
9.97
10.75
4.34
3.87
5.28
5.06
0.88
4.16
3. 49
4.56
-4.16
-0.53
2.78
-0.87
0.89
1.11
1.21
-7.93
2.30
-2.50
-4.69
1.00
0.97
-0.22
5.38
-3.99
-0.61
2.88
0.67
-6.29
4.72
1.14
-3.83
2.91
1.27
7.27
2.62
-0.64
-0.50
-1.18
-2.36
-0.20
2.24
3.31
3.38
11.02
7.34
6.26
1.66
3.07
-8.26
8.10
2.33
10.90
2.74
7.57
1.79
-0.61
0.67
-7.42
-4.95
-5.41
9.32
1.02
-0.24
1.18
0.91
-0.48
3.28
-2.80
1.34
1.11
-2.45
-0.64
2.95
-1.49
3.31
1.09
5.60
-1.69
-4.90
0.86
-1.53
4.08
2.28
3.63
-7.52
-1.65
5.49
1.64
-1.97
3.07
0.29
5.07
-1.89
7.53
12.45
-1.72
-1.06
4.36
5.18
3.95
1.94
1.15
5.59
4.37
2.75
0.89
8.21
3.42
AUG
1.59
-1.08
-2.55
-3.24
1.69
-5.82
2.47
-2.41
3.15
0.58
6.44
4.35
3.05
1.53
-9.14
2.42
3.70
SEP
OCT
NOV
DEC
FULL
(1)
YEAR
1.99
-4.14
6.13
4.80
-17.17
-3.03
-1.37
1.25
5.32
1.60
-4.22
-2.94
9.05
-4.66
7.33
1.22
1.00
0.50
10.26
5.39
2.86
-0.12
6.87
5.17
-1.73
0.11
2.43
0.23
5.96
-3.78
-1.79
3.68
3.31
1.11
-0.81
-0.24
1.92
6.36
-17.10
-4.12
4.28
-3.75
5.13
3.92
0.33
-2.70
-1.29
-7.82
-2.95
0.58
2.04
-3.12
5.76
1.74
6.61
-3.70
0.79
1.68
-1.98
2.41
5.22
3.34
2.16
11.25
-2.99
-4.68
-1.11
0.29
4.81
13.93
35.85
76.41
-36.91
12.72
26.07
6.32
16.67
44.54
-3.36
43.73
45.71
-7.82
-2.99
26.20
16.60
Notes: (1) Data are as of Mar. 29, 2013.
Source: Bloomberg.
The indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Index returns do not include any expenses, fees, or sales charges, which would lower performance. Past performance is no
guarantee of future results.
The Alerian MLP Index is a float-adjusted, capitalization-weighted index of the 50 most prominent energy master limited partnerships..
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MORGAN STANLEY WEALTH MANAGEMENT | APR. 24, 2013
Please refer to important information, disclosures and qualifications at the end of this material.
Morgan Stanley Wealth Management Global Investment Committee – Asset Class Reviews
1.
Publicly Traded Real Estate Shares and REITs
2/27/12
2.
High Yield Fixed Income
3/26/12
3.
US Investment Grade Fixed Income
4/23/12
4.
Inflation-Indexed Securities
5/21/12
5.
Emerging Markets Fixed Income
6/25/12
6.
Hedge Funds
7/30/12
7.
Emerging Markets Equity
8/27/12
8.
Commodities
9/24/12
9.
Non-US Equity
10/22/12
10.
Non-US Fixed Income
11/26/12
11.
Gold
12/10/12
12.
Managed Futures
13.
US Equity
2/19/13
14.
US Cash and Cash Equivalents
3/25/13
15.
Master Limited Partnerships
4/22/13
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MORGAN STANLEY WEALTH MANAGEMENT | APR. 24, 2013
1/28/13
Please refer to important information, disclosures and qualifications at the end of this material.
Risk Considerations
Master Limited Partnerships (MLPs) are limited partnerships or limited liability companies that are taxed as partnerships and whose interests (limited partnership units or limited liability company units) are traded on securities exchanges like shares of common stock. Currently, most MLPs operate in the energy, natural resources or real estate sectors. Investments in MLP interests are subject to the risks generally applicable to companies in the energy and
natural resources sectors, including commodity pricing risk, supply and demand risk, depletion risk and exploration risk.
MLP Risks
Individual MLPs are publicly traded partnerships that have unique risks related to their structure. These include, but are not limited to, their reliance on the
capital markets to fund growth, adverse ruling on the current tax treatment of distributions (typically mostly tax deferred), and commodity volume risk.
For tax purposes, MLP ETFs are taxed as C corporations and will be obligated to pay federal and state corporate income taxes on their taxable income,
unlike traditional ETFs, which are structured as registered investment companies. These ETFs are likely to exhibit tracking error relative to their index as a
result of accounting for deferred tax assets or liabilities (see funds’ prospectuses).
The potential tax benefits from investing in MLPs depend on their being treated as partnerships for federal income tax purposes and, if the MLP is deemed
to be a corporation, then its income would be subject to federal taxation at the entity level, reducing the amount of cash available for distribution to the
fund which could result in a reduction of the fund’s value.
MLP funds accrue deferred income taxes for future tax liabilities associated with the portion of MLP distributions considered to be a tax-deferred return of
capital and for any net operating gains as well as capital appreciation of its investments; this deferred tax liability is reflected in the daily NAV; and, as a result, the MLP fund’s after-tax performance could differ significantly from the underlying assets even if the pre-tax performance is closely tracked.
For additional risks, please see the Disclosures section beginning on page 7 of this report.
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MORGAN STANLEY WEALTH MANAGEMENT |
APR. 24, 2013
Please refer to important information, disclosures and qualifications at the end of this material.
Disclosures
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MORGAN STANLEY WEALTH MANAGEMENT | APR. 24, 2013
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