He points to the “energy renaissance” as a long-term driver that will support growth in payouts to investors. Oil and natural gas production has surged since the mid-2000s, when the extraction method known as “fracking” took hold. This spike has created additional demand for infrastructure investments such as processing and transportation services, the bread and butter of master limited partnership companies.



Reid believes including MLPs in his fund’s energy infrastructure investment mix provides several benefits, including:

Diversification and good risk-adjusted returns. Between June 2006 and the end of last year, the Alerian MLP Index had a correlation of 53% to the S&P 500, 62% to high-yield bonds, 28% to the MSCI U.S. REIT Index and 43% to crude oil. Over the same period, the Alerian MLP Index, with only a slightly higher standard deviation, returned 15.6% annually, while the S&P 500 returned 7.4%.

Inflation protection. As a group, MLPs have grown payouts at a rate averaging 7.8% a year since 2001, over three times the rate of inflation. Many of the businesses themselves have internal inflation hedges, since certain types of pipelines that are regulated by the Federal Energy Regulatory Commission are able to increase tariffs annually.

Tax benefits. Even though these publicly listed securities trade much like common stock, the MLP partnership structure allows investors to defer taxes on distributions, which are treated as a return of capital and taxed at favorable rates. (Since the fund also invests in the stocks of the general partners, which pay traditional dividends, only a portion of its income is treated in that manner.)

But there are also some potential drawbacks, including:

Possible dividend cuts. Three MLPs (none of them in Reid’s fund) slashed distributions this year. One of them, Boardwalk Pipeline Partners (BWP), saw a 46% drop in its stock price in February after it announced a massive payout cut, although it gained back some of that lost ground during the summer. Reid believes that “things look fairly static for now” as far as further cuts are concerned.

Tax uncertainty. One reason MLPs can pay out so much income is that their partnership structure allows them to circumvent federal income tax at the corporate rate. If that were to change, the amount of cash available for distribution would likely fall and shareholders would receive less favorable tax treatment on distributions.

While the tax status of MLPs has not been specifically challenged, they could fall into the crosshairs of legislators seeking to drum up revenue. Reid thinks this is unlikely to happen, though.