They are masterpieces of the income investment universe.
Each one is specially designed to throw off secure income,
steadily grow distributions and bring above-average returns.
They're master limited partnerships (MLPs).
In the past 10 years, MLPs have been on a tear.
Magellan Midstream Partners (NYSE:
MarkWest Energy Partners (NYSE:
Energy Transfer Partners (NYSE:
-- three of the largest MLPs -- are all up more than 450% since
But despite their popularity as of late, there is one caveat
when it comes to investing in MLPs: taxes can be complicated.
Because of their unique tax structure, you generally don't want
to hold MLPs in tax-sheltered
or 401(k) types of accounts. If your MLPs throw off more than
$1,000 of combined
unrelated business taxable income (UBTI)
-- income that's not related to the tax-exempt purpose of your
account -- then your account could suffer some severe
But fortunately for us, there is a
Unlike individual MLPs, MLP-focused funds let you own as many
MLPs as you want in your tax-sheltered account without creating a
Usually, funds are regulated investment corporations (RICs), but
a regulated investment company by law can't have more than 25% of
its portfolio in MLPs. So to keep their fund structure, many of
these MLP-focused funds opt to be treated as an ordinary "C"
for tax purposes.
As a regular corporation, the fund is taxed at the 35% marginal
rate on the
portion of the MLP distribution. Then, you the investor are taxed
again at the currently reduced 15%
Now, here's where it gets interesting.
The fund, like an individual investor, is not taxed on the
return of capital portion of the MLP distribution when received.
Instead, taxes accrue until the security is sold. These accrued
taxes make up a portion of what's called deferred tax liability
This DTL is reported in the
, which for a fund is called a statement of assets and liabilities.
The assets less the liabilities equal the fund's
net asset value
As the name implies, DTL is on the
side of the books, along with
obligations. That's because DTL is the amount of taxes the fund may
need to pay at some future time when it sells its MLP holdings.
But DTL isn't a liability in the same sense as debt obligations.
DTL is a non-cash
. It doesn't affect the fund's future
like debt obligations. It reflects future payments, but only if the
assets are sold. If a fund has a very low portfolio turnover rate
of, say, less than 25% of its holdings each year, the fund is not
likely to incur that liability for a long time, if ever.
With low turnover portfolios, then, DTL acts more like an
that keeps growing than a liability that the fund owes.
Therefore, adding back DTL to the latest reported net asset
value, instead of subtracting it, gives a more accurate measure of
the fund's underlying value when compared with non-MLP focused
I'llcall this measure Pasternak's "normalized net asset value"
(NNAV) because it allows us to compare MLP funds with normal
closed-end funds that typically don't carry DTL on the books. In
other words, Pasternak's NNAV allows us to compare apples with
Using Pasternak's NNAV, I unlocked the hidden value in
MLP-focused funds. Funds that may appear to be selling at a steep
premium to their asset value now look to be attractively
First, I screened for funds with a low portfolio turnover rate
of 25% or below. Then, I calculated the DTL per share based on
information provided in the statement of assets and liabilities in
I ranked the remaining funds by the greatest amount of DTL on
their books, then selected the top five. In the list below, I
compare each fund's price to the reported
and the NNAV as ag June 8. As you see, once DTL is added back so as
to normalize the net asset value, some real bargains emerge.
All of these funds carry rich yields of around 6% to 7% based on
the past year's payouts. And, as noted before, you can hold these
funds in a tax-sheltered account without tax liability
Each of these funds warrants a closer look at their portfolio
holdings, distribution history,
, and returns. I am especially intrigued by
Tortoise Energy Infrastructure (NYSE:
, since adding back its deferred tax liability has the most
dramatic effect on valuations among the five funds listed.
Risks to Consider:
Let me warn you, though, if you're thinking about investing
here, then most MLP-focused closed-end funds take on
, which can make returns more volatile than with an individual MLP
Action to Take -- >
But if you've ever wanted to invest in MLPs but you're worried
about the tax implications, then consider investing in an MLP
focused closed-end fund. It's one of the easiest ways to simplify
the headache, and still gain exposure to these high-yield
-- Carla Pasternak
Carla Pasternak does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.
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