A Master Limited Partnership (MLP) is most commonly found in the energy industry and it helps provide the capital companies need to expand and explore in a tax-efficient way that appeals to investors who are prepared for a bit of a choppy ride with their money at times.
An MLP investor is usually called a unitholder rather than a shareholder and this is just one of several noticeable differences compared to other investment opportunities. Once you are alive to the tax benefits and potential returns offered by MLPs the big question is how to find the best performers.
Here is a brief overview of MLPs, a look at why you might want to invest and the risks you face, plus some insights on how to pick the potential winners and avoid the losers.
Limited exposure to commodity prices
Once you have gained an understanding of what MLPs are and how they might work for you as an investment vehicle for some of your money, you will no doubt want to find a way to negotiate the smoothest path possible to a profit.
It has to be said that although MLPs were once considered to be one of the safest ways to gain some investment exposure to the energy sector mainly because you often had limited exposure to the volatility of commodity prices, that reputation took a bit of a knock with the downturn that had a widespread impact on the industry.
If you want to keep up to date with the latest developments you can always visit online at OilandEnergyInvestor.com for news and reports. In terms of investing in MLPs, there are some noticeable characteristics to look out for which could make a difference to the returns you manage to achieve.
It is worth pointing out that while you can hopefully manage to plot a slightly safer route towards a profitable return through selective exposure to MLPs, you should still be fully prepared for a certain amount of volatility.
If you look at the general performance of MLPs during 2015 and 2016, oil prices and investor sentiment affected the stability of prices, but if you want to do a direct comparison between this sector and the S&P 500 over the last ten years, MLPs only had a 4% higher deviation.
As with many investment opportunities, it often pays to play the long game and ride out the short-term storms that can spook some investors, who end up crystallizing their losses rather than waiting for things to recover.
Cream rises to the top
Now that you have got things straight about the structure, risks, and rewards associated with MLPs, the next step is to find a way to try and find the best performers in this sector.
Probably one of the best tips to consider is the idea that if you search out MLPs that feature top investment-grade companies, in other words, those that have some serious balance sheet strength to fall back on in times of trouble, these have tended to fare better than their weaker counterparts.
For example, Enterprise Products Partners enjoys one of the highest credit ratings in the MLP sector, whereas someone like Energy Transfer Partners has one of the lowest. If you look at how these two companies performed in a downturn, the MLPs with the highest credit rating didn’t drop anywhere near as far as those with the lowest.
Strength in numbers is the name of the game and if you stick with MLPs who have a solid balance sheet that is reflected in their high credit rating, you seem to be more likely to enjoy less volatility and rewarded with better recovery when the market rises again.
Cash is king
Not the first time you will have heard that phrase but it is relevant when talking about the strength of MLPs and finding the ones that will be in a position to take advantage of new opportunities.
It can often pay to look for a company that is more keen on retaining cash in the business than distributing it to unitholders. That may not seem such an attractive policy if you like the idea of dividends but an MLP that doesn’t have to resort to a round of asset sales or exotic financial instruments to raise cash is going to find it easier to invest in growth projects.
MLPs are an investment opportunity worthy of consideration, as long as you understand the risks and appreciate the fact that not all MLPs are the same.
Shane Otwell shares his investment insights with an online audience. Having worked in investment banking for many years, Shane has a wealth of information ready to get you on your way.