Are master limited partners unsuitable for some investors? The term master limited partnership sounds like a complicated legal transaction. In fact, master limited partnerships or MLPs are complex investments that have become hugely popular in the last few years in this low interest rate environment. MLPs are tax exempt publicly traded companies that often own infrastructure in the energy field (pipelines, tanks, etc.). Individual and small institutional investors having be loading up on MLPs because they pay a large percentage of their income out to shareholders as distributions. According to Morningstar, investors added almost $12 billion in 2014 into mutual and exchange-traded funds which invest in MLPs. That’s a huge amount of hard earned money looking for higher yields. The question is, do investors understand the real risks? We doubt it.
Brokers commonly market MLPs as low risk, higher yield securities. But that’s not the case. An MLP is a publicly traded limited partnership with two types of partners: the general partner (or GP) who is responsible for managing the MLP and is compensated for performance; and the limited partner (or LP) who is the investor who provides the capital to the MLP and receives periodic income distributions. Unlike most partnerships, shares of MLPs can be bought or sold on a stock exchange. Just like any partnership, the problem with being a limited partner is that an LP has no role in the management of MLP. That’s risk number one.
Risk number two is that most MLPs invest in the natural resources infrastructure. This is normally a risky space, especially with the swings on energy and commodity prices.