Income investing is always a popular strategy for portfolio allocation that t is perhaps most effective in sideways markets, when few asset classes are generating stable returns. With today’s major indices swaying back and forth with each coming day, many analysts feel that we are indeed in a sideways environment, bringing value investing to the forefront. Of the numerous value options, few are as enticing as the Master Limited Partnership (MLP) sector. These products offer juicy dividend yields and make a play on the world’s insatiable appetite for fossil fuels [see also Three Things Wall Street Journal Didn’t Tell You About Commodities].
Over the past decade, MLPs have provided some of the best returns of any asset class on the market. In fact, over the trailing decade, the Alerian MLP Index “of 50 prominent MLPs has outperformed REITs, the Dow Jones Industrial Average, utilities and the S&P 500″ writes Ed McCarthy. These partnerships focus on oil and natural gas pipelines, as they build new and upkeep the current infrastructure for much of the world’s energy usage. The funds often come with extremely enticing dividend yields, but some products come with K-1s which can be a major headache come tax season [see also Crude Oil Crushed: Buy or Sell?].
The biggest issue when it comes to MLP investing hits home when it comes time to make an allocation. Investing in any single firm can be dangerous, as a number of stocks have language buried deep in the prospectus that states the ticker is designed to last for a only certain period of time. Also, with the wild swings that crude oil is prone to exhibit, exposure to just one firm leaves you fully at the mercy of this company and whether or not they are strong enough to handle today’s market woes. As with any asset class, a diversified investment approach is the way to go, as there are numerous options that provide exposure to a basket of these high-paying firms with just a single ticker. But with CEFs, ETPs, and mutual funds dedicated to this market segment, it can be hard to decide which option is the best for your portfolio’s particular needs [see also Dividend Special: Top Companies In Every Major Commodity Sector]:Closed-End Funds (CEFs)
Though similar to mutual funds, CEFs have several key characteristics that set them apart from the investing world. CEFs trade like stocks, meaning that there is the typical brokerage fee involved as well as a fee to the managing company. Investors need to be aware of the bid-ask spread on these investment vehicles, as there are typically large gaps that can erode value if they are not properly accounted for. CEFs, like ETPs, have an underlying Net Asset Value (NAV), and very rarely trade in line with it, creating a unique opportunity depending on whether or not the security is trading at a discount or premium. Closed products are relatively illiquid and are not meant for traders, but rather for the “buy-and-hold” investor who truly believes in the underlying structure [see also Major Countries Burn Up Crude Reserves: Big Oil In Trouble?].
MLP ETFs and ETNs have grown rapidly in recent years, as there are now numerous options dedicated to this coveted asset class. The ETF structure is similar to CEFs in that it has an NAV that is often trades away from, however ETPs in general are far more liquid options. ETNs on the other hand, do not incur tracking error and will always trade at their NAV, though they come handcuffed with the credit risk of the issuing firm. In general, ETPs will offer the most competitive fee structure in the space, and will also be the best option for traders because of their ease-of-use in market environments [see also The Guide To The Biggest Companies In Every Major Commodity Sector].
Mutual funds are the grandfathers of the investing world. They feature active management and have been around for decades, allowing investors to gain access to asset classes that were once hard to reach. Their structure is relatively illiquid, but for investors who feel that active management is the best way to go, mutual funds are the best option for your portfolio. They can change holdings on a moment’s notice to protect returns, though they often charge hefty fees because of this feature. The MLP sector is relatively new to mutual funds, with only a handful of young products on the market [see also Analyzing Five High Yielding Oil & Gas Pipeline Stocks].
Disclosure: No positions at time of writing.