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An Introduction to MLPs: A Framework for Investment

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Overview of MLPs

MLPs are publicly traded partnerships that generally operate in energy and natural resources. MLPs are pass-through entities that don’t pay corporate tax. Instead taxes are paid at the unit holder (or shareholder) level. Most MLPs operate in the midstream energy sector, which includes transportation (pipeline), gathering and processing (or G&P), and storage. Other energy MLPs operate in exploration and production (or E&P) and refining.

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How MLPs came into existence

The Tax Reform Act of 1986 created tax-free publicly traded partnerships, while the Revenue Act of 1987 requires that these entities generate at least 90% of their gross income from the following: E&P, mining for coal or other minerals, timber, G&P, refining, compression, transportation, storage, marketing, distribution, or retail sales from propane.

Who can own MLPs?

MLPs were traditionally held by retail investors until 2000. Ownership by institutional investors has grown significantly since then. Now corporate parents or sponsors hold significant interest in them. Mutual funds can invest in MLPs since the American Jobs Creation Act was passed in October 2004. However, there are some restrictions:

  • A mutual fund can’t invest more than 25% of its asset value in MLPs.
  • A fund may not invest more than 10% in any one MLP.

From the above chart we can see that retail investors form the largest base of investors in MLPs.

Some of the largest MLPs in terms of market cap are Enterprise Product Partners (EPD), Energy Transfer Partners (ETP), Williams Partners (WPZ), and Plains All American Pipeline (PAA). These MLPs have a combined weight of 37.85% in the Alerian MLP ETF (AMLP).

In the next article, we’ll discuss how MLPs are placed today and what sectors MLPs primarily operate in.

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