The outlook is good, but there is no free lunch. Experts have warned that as limited partners, clients could wind up footing some unexpected bills, such as each partnership's state and local taxes.
With fewer than 100 publicly traded master limited partnerships, the units could prove tough to sell. Master limited partnerships lost about 50% from mid-2006 through mid-2008, according to the Alerian MLP index.
Be advised that exchange-traded MLP funds could get hit hard during a financial collapse because of tracking errors and illiquidity, which makes it difficult for market makers to keep the stock price and asset value of the funds in sync. Exchange-traded notes are debt obligations-exposing investors to counterparty risk if the banks default.
In June, J.P. Morgan announced that it had capped the new issuance of its J.P. Morgan Alerian MLP Index ETN (exchange-traded note) at $4.7 billion. It is the second cap, based on published reports, that the big bank put on the fund this year amid its large trading losses and risk in the credit markets. As a result of the cap, the note began trading like a closed-end fund with the share price trading at a premium to the asset value of the note.
Ike Ikokwu, a Cumming, Ga.-based CPA and financial planner, says that advisors who want to invest in master limited partnerships should look for companies with a strong history of earnings growth, earnings distributions, strong balance sheets and access to capital-liquidity that can allow them to continue their growth plans. MLPs with strong balance sheets are likely buyers if the industry consolidates.
But Ikokwu typically does not invest in master limited partnerships. He prefers to put clients in separately managed, well-diversified accounts. If his clients want to invest outside of these accounts in a master limited partnership for income, he likes Kinder Morgan Energy Partners, a pipeline transportation and energy storage company. He favors alternative income investment opportunities that don't have the same problems of losing specific tax benefits master limited partnerships afford when held in retirement accounts. Plus, he favors those that can produce high-single-digit or low-double-digit annual returns.
"Considering that the managers create various income and alternative portfolios with similar types of assets, the goal of adding an income-producing asset, whether through limited partnerships or alternative investments, can and is achieved [by separately managed accounts]."