Master Limited Partnerships - People Are Looking Elsewhere for Different Investment Ideas You Might Not Have Considered
Ric Edelman: You're listening to The Truth About Your Future. Let me tell you the truth about the present. Interest rates at historic lows. That's a big problem if you're an income oriented investor, meaning retiree, drawing money from your investments to support your lifestyle. You know, earning 1% on your investments, you know, that's bad enough. But now with inflation, the situation is downright scary. You're losing money on every dollar you have in bank accounts and low yielding investments like bonds. This is forcing people to look elsewhere for different investment ideas that maybe you've never even considered before, maybe you've never even heard of before. Well, I want to introduce you to one of these ideas. And to help us do this, I'm welcoming onto the program Rohan Reddy. He's Director of Research at Global X ETFs. Rohan's expertise is in energy, infrastructure and dividend strategies, and he's also on Global X ETFs Portfolio Construction Committee. Rohan, thanks so much for joining us on the show today.
Rohan Reddy: Great to be here. Ric.
Ric Edelman: Well, the conversation that we're going to get into pertains to MLPs, master limited partnerships. I think, Rohan, most folks are unfamiliar with these things. So give us a rundown. What is a master limited partnership, an MLP, and how do they work?
Rohan Reddy: A master limited partnership is a unique structure that was set up a few decades ago in the United States. They do not pay federal income taxes, so they're pretty attractive to income investors. Oil and gas is the primary entities that are held within the MLPs structure pipelines. They have oil and gas flowing through those pipelines. And because of the consistency of those pipeline flows, they're able to pay out regular dividends to shareholders.
Ric Edelman: And so what kind of dividends are we talking about? What kind of interest rate from dividends can you expect to receive?
Rohan Reddy: Yes, today MLPs are yielding in the 7% range. One other unique aspect about MLPs is they pay out return of capital dividends. So you are typically not taxed on the underlying distributions that you receive. So that makes it from even a post-tax perspective more attractive to income investors.
Ric Edelman: All right. So let's unpack this a little bit, because you're saying a couple of things that I think is really getting a lot of folks ears to perk up: 7% dividends and tax free. So let's unpack both of those a little bit. 7%, is that something that is temporary or can you reasonably expect to enjoy a sustained high interest rate like that for a long period?
Rohan Reddy: Well, the business model of MLPs has changed quite a bit, as with a lot of oil and gas companies. So in the past, a lot of investors preferred a growing the dividends aggressively and paying out to shareholders as much as possible because the shell production cycle in the United States was super high. However, today that's changing a little bit. We're more conservative. Dividend policies have been put into place that are more focused on stability. So actually these 7% yields seem fairly manageable today. We do think for a lot of income investors, this is a good time to be in MLPs and that the risk of major dividend cuts is not as high as it is during the low oil price environment.
Ric Edelman: And now elaborate a little bit more on this tax free benefit that you mentioned, a return of capital. Explain how that works.
Rohan Reddy: Yes, that's another unique part of the MLPs structure, is that because it's technically a partnership, it's sort of like how it would work if you were to set up a business as a partnership. So actually when you buy into MLPs, you're not necessarily considered a shareholder like you would be in, say, a stock like Apple. But you're considered a unit holder with a partnership interest in the business. So that's why when you get distributions that are paid to you, those are considered return of principal. So essentially you're getting your money back. So you're not actually being taxed on those distributions.
Ric Edelman: Which makes the after tax effective yield even higher.
Rohan Reddy: Yes, exactly. The trade off on that is because you're getting more post-tax income. Your basis does get lowered by the amount of the distribution that you received.
Ric Edelman: So let's make sure people understand this. Let's say that you invested $10,000 and you're getting some of these dividends on a tax free basis. That's lowering the $10,000 cost basis so that if you were to sell, you would actually pay taxes at that point. If you never sell, you pass those assets at death and your heirs won't pay the taxes either.
Rohan Reddy: Exactly. So with the step up in basis, it makes it even more attractive for unit holders and MLPs to hold on to those assets and then pass it through in the estate planning cycle.
Ric Edelman: Got it. So how much of this is related to the fact that oil prices have been at all time high prices? If oil prices fall, would that create a risk in this investment?
Rohan Reddy: Yes. MLPs, they may be a little bit more immune to some of the direct oil price risk compared to exploration and production and drilling companies. However, it is a volume-based business. So if there is risk that oil prices do fall, as we've seen in the years prior to COVID, when prices were fairly low, that does raise the risk that there could be a lower level of volumes or lower levels of revenue received for transporting those volumes through the pipeline. So we do think as long as oil prices remain fairly elevated at least, or at least above the, say, $70 to $80 range in the US, that's a pretty good area to be in for MLPs. Because most oil and gas companies are breaking even or making a profit. The risk is more so if prices start falling rapidly, or if they remain lower for a longer period of time, because then there is a heightened risk that there could be lower volumes coming from those oil and gas properties.
Ric Edelman: Okay. So that's really important for folks to understand, is that you are essentially investing in the oil market and in addition to the dividend that you're receiving, the price of your shares are going to be fluctuating based on the prices of oil. Is that fair to say?
Rohan Reddy: Exactly. So this should not be thought of as a bondlike investment anyway. It's absolutely very equity like. There is some growth potential, of course. Where if these businesses start growing and they get more customers and the US shale industry continues to grow, that's a really good spot for MLPs to be in. However, on the downside, there is some risk too that a lot of the way that MLPs and their prices move is correlated to how the energy industry does.
Ric Edelman: In addition to oil prices fluctuating. Let's talk about interest rates fluctuating. We're clearly in an environment right now where interest rates are beginning to rise. We've already had the Fed begun that process and everybody's widely expecting more interest rate increases as the year progresses. Do rising interest rates help or hurt an investment in MLPs?
Rohan Reddy: Historically, when you look at income investments, they usually do not perform as well during the rising rate environment, just by the fact that the yield spread that you're getting relative to, say, treasuries, is maybe not as high as it was earlier in the cycle. However, the one thing that's unique about MLPs is because they're oil and gas businesses, usually we've seen in prior cycles, when interest rates start to rise, that typically means inflation is high, which it is today. And that's a very good for energy businesses because that means that energy prices are higher. So actually MLPs tend to do very well historically during rising rate environments because energy prices and thus the energy industry as a whole is doing well. So actually, this is a pretty good time to get into the energy industry and specifically MLPs.
Ric Edelman: It sounds intriguing, certainly something worthy of investors to talk with their financial advisors about. But the notion of an MLP, I think, is kind of like the notion of an individual stock. And most investors don't buy individual stocks, they buy funds, they buy ETFs. And of course, Global X is one of the largest providers of ETFs in the marketplace. So there is a Global X ETF that invests in these master limited partnerships. Tell us about that.
Rohan Reddy: Yes, we offer two in the space. Ticker MLPA is the Global X MLP ETF. It's focused exclusively on master limited partnerships and it's a basket of about 20 MLPs, most of which are the largest and most liquid in the space. And from there, our fund, for example, offers around a 7% yield and it tracks the price of the underlying NLP industry quite well. We offer another ETF ticker, MLPX, which includes a mix of both master limited partnerships and also C Corp energy infrastructure companies.
Ric Edelman: And what allocation would you suggest is appropriate for someone in a diversified portfolio? How much of their money should be placed into MLP investments?
Rohan Reddy: Naturally, we've seen more of a tilt towards income investors and income portfolios. So if you are running an income portfolio or you're allocating towards it, we have seen investors put even yield levels from 5% all the way up to 10% of their portfolio into MLPs. And then if you're running either a slightly more conservative portfolio or something that's less allocated towards income, we've seen anywhere from 1% to 3%. So these levels seem fairly low, but some of these investments can be a little bit volatile. But we have seen more of a preference towards a higher weighting within income oriented portfolios.
Ric Edelman: So if you're looking for a way to get a little extra income from your portfolio, you might want to consider master limited partnerships and the two ETFs offered by Global X ETFs, MLPA and MLPX. That's Rohan Reddy, the Director of research at Global X ETFs here on The Truth About Your Future. Rohan, thank you so much for joining us.
Rohan Reddy: Thanks for having me, Ric.
Ric Edelman: Rohan and I actually talked for about 15 minutes on the program. If you would like to read, watch or listen to the entire conversation, just visit us at TheTruthAYF.com.